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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 29, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27559
TEXTRON FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 05-6008768
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
40 WESTMINSTER STREET, P.O. BOX 6687, PROVIDENCE, R.I. 02940-6687
(401) 621-4200
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF CLASS WHICH REGISTERED
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$400,000,000 FLOATING RATE NOTES NEW YORK STOCK EXCHANGE
DUE DECEMBER 9, 2002
$600,000,000 7 1/8% NOTES NEW YORK STOCK EXCHANGE
DUE DECEMBER 9, 2004
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $100.00 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]. No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. (Not applicable).
All of the shares of common stock of the registrant are owned by Textron
Inc.
REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I (1) (a)
AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED
DISCLOSURE FORMAT.
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TABLE OF CONTENTS
PART I.
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 14
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 14
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 14
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 16
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 24
Item 8. Financial Statements and Supplementary Data................. 25
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 50
PART III.
Item 10. Directors and Executive Officers of the Registrant.......... 50
Item 11. Executive Compensation...................................... 50
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 50
Item 13. Certain Relationships and Related Transactions.............. 50
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K............................................... 50
2
PART I.
ITEM 1. BUSINESS
GENERAL
Textron Financial Corporation (Textron Financial or the Company) is a
diversified commercial finance company with core operations in four segments:
Aircraft Finance, Revolving Credit, Specialty Finance and Structured Capital.
The Aircraft Finance segment is focused on financing Cessna aircraft, Bell
helicopters and other general aviation aircraft. The Revolving Credit segment
specializes in dealer floorplan financing, asset-based lending and small
business financing. The Specialty Finance segment includes golf course and
equipment finance, financing for developers of vacation interval resorts and
residential and recreational land lots, franchise finance and media finance. The
Structured Capital segment includes leveraged lease transactions and investment
grade and near investment grade structured secured term and revolving credit
facilities. This segment also originates factoring arrangements and working
capital loans in the telecommunications, trucking and specialty financial
services industries. Textron Financial's other financial services and products
include transaction syndications, equipment appraisal and disposition, portfolio
servicing and insurance brokerage.
All of Textron Financial's stock is owned by Textron Inc. (Textron), a $12
billion multi-industry company with businesses in Aircraft, Fastening Systems,
Industrial Products, Industrial Components and Finance. At December 29, 2001,
22% of Textron Financial's total managed finance receivables were related to
Textron or Textron's products (Textron-related receivables). Textron Financial
has full recourse to Textron on 60% of managed Textron-related receivables. For
further information on Textron Financial's relationship with Textron, see
"Relationship with Textron" below.
Textron Financial's financing activities are confined almost exclusively to
secured lending and leasing to commercial markets. Textron Financial's services
are offered primarily in North America. However, Textron Financial does finance
Textron products worldwide, principally Bell helicopters and Cessna aircraft in
South America.
Textron Financial employs approximately 1,200 people in 42 offices
throughout North America. Primary operations centers are located in Little Rock,
AR; Tempe, AZ; East Hartford, CT; Alpharetta, GA; Wichita, KS; Williamstown, MA;
Minneapolis, MN; Columbus, OH; Portland, OR; King of Prussia, PA and Providence,
RI, also the location of the Company's headquarters.
DESCRIPTION OF BUSINESS SEGMENTS AND OPERATING UNITS
Textron Financial provides a wide range of financing, leasing and related
services through the following four core business segments:
- Aircraft Finance
- Revolving Credit
- Specialty Finance
- Structured Capital
For additional information regarding Textron Financial's business segments,
see below and Note 18 to the consolidated financial statements in Item 8 of this
Form 10-K.
Aircraft Finance
Aircraft Finance -- Textron Financial provides financing to commercial
users and, to a minor extent, consumer users of new and used Cessna business
jets and piston-engine aircraft, Bell helicopters and other general aviation
aircraft.
3
The following table sets forth certain financial information regarding the
Aircraft Finance segment for the periods indicated:
<Table>
<Caption>
2001 2000 1999
---------- ---------- ----------
(In thousands)
AIRCRAFT FINANCE
New business volume(1)................................. $ 813,822 $ 771,833 $ 853,662
Total finance assets................................... 1,248,305 1,088,811 1,464,533
Revenues............................................... 124,643 161,172 103,264
Nonperforming assets................................... 13,123 26,525 11,575
Revenues as a percentage of total revenues............. 17.57% 23.34% 22.31%
Ratio of net charge-offs to average finance assets..... 0.70% 0.15% 0.20%
</Table>
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(1) Excludes finance receivables of $229 million in 1999 that were purchased in
a business acquisition.
Revolving Credit
Floorplan Finance -- Textron Financial structures inventory finance
programs for dealers and distributors of music, marine, portable spa, wood
stove, lawn and garden, specialty trailer, motor home, manufactured housing and
telecommunications products. Textron Financial also provides programs for
Textron Golf, Turf and Specialty Products and OmniQuip.
Commercial Lending -- Textron Financial provides working capital lines of
credit secured by trade accounts receivable and inventory to middle-market
companies.
Small Business Finance -- Textron Financial provides financing to small
businesses through unsecured lines of credit, conventional term financing and
SBA guaranteed term loans.
The following table sets forth certain financial information regarding the
various businesses included in the Revolving Credit segment for the periods
indicated:
<Table>
<Caption>
2001 2000 1999
---------- ---------- ----------
(In thousands)
FLOORPLAN FINANCE
New business volume.................................... $2,216,568 $1,647,985 $1,201,224
Total finance assets................................... 499,272 861,304 588,161
Revenues............................................... 89,807 84,862 61,949
Nonperforming assets................................... 13,798 8,241 5,692
Revenues as a percentage of total revenues............. 12.66% 12.29% 13.38%
Ratio of net charge-offs to average finance assets..... 0.67% 0.37% 0.22%
COMMERCIAL LENDING
New business volume.................................... $ 268,278 $ 351,827 $ 333,237
Total finance assets................................... 285,529 380,158 305,834
Revenues............................................... 32,450 35,854 27,914
Nonperforming assets................................... 3,820 26,214 15,529
Revenues as a percentage of total revenues............. 4.58% 5.19% 6.03%
Ratio of net charge-offs to average finance assets..... 3.28% 1.93% 1.62%
</Table>
4
<Table>
<Caption>
2001 2000 1999
---------- ---------- ----------
(In thousands)
SMALL BUSINESS FINANCE
New business volume(1)................................. $ 198,818 $ 13,934 $ 13,045
Total finance assets................................... 436,950 16,604 20,187
Revenues............................................... 36,328 3,112 7,565
Nonperforming assets................................... 4,638 997 749
Revenues as a percentage of total revenues............. 5.12% 0.45% 1.63%
Ratio of net charge-offs to average finance assets..... 5.09% 2.70% 1.31%
</Table>
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(1) Excludes finance receivables of $401 million in 2001 that were purchased in
a business acquisition.
Specialty Finance
Receivables Finance -- Textron Financial offers inventory and notes
receivable financing to developers of vacation interval resorts and residential
and recreational land lots. Acquisition and construction loans are also provided
to these developers.
Golf Course and Equipment Finance -- Textron Financial provides first
mortgage loans for the acquisition, refinancing and construction of golf courses
and golf resort properties. The Company also provides term financing and leasing
services for Textron products including E-Z-Go golf cars and Textron Turf Care
equipment.
Franchise Finance -- Textron Financial offers term finance programs to
franchisees of well-established franchise concepts for business acquisitions,
new store development, image enhancements, equipment upgrades and debt
refinancing.
Media Finance -- Textron Financial provides finance programs to broadcast,
publishing, cable television and other media operators for working capital,
acquisitions, facility upgrades and debt refinancing.
The following table sets forth certain financial information regarding the
various businesses included in the Specialty Finance segment for the periods
indicated:
<Table>
<Caption>
2001 2000 1999
---------- -------- --------
(In thousands)
RECEIVABLES FINANCE
New business volume(1).................................... $ 821,091 $739,146 $671,163
Total finance assets...................................... 1,021,034 855,855 834,818
Revenues.................................................. 106,072 117,884 50,137
Nonperforming assets...................................... 9,996 8,225 8,533
Revenues as a percentage of total revenues................ 14.96% 17.07% 10.83%
Ratio of net charge-offs to average finance assets........ 0.08% 0.36% 0.15%
GOLF COURSE AND EQUIPMENT FINANCE
New business volume....................................... $ 434,252 $512,854 $463,061
Total finance assets...................................... 842,153 741,477 758,754
Revenues.................................................. 68,144 82,829 54,357
Nonperforming assets...................................... 6,947 3,694 12,116
Revenues as a percentage of total revenues................ 9.61% 12.00% 11.74%
Ratio of net charge-offs to average finance assets........ -- -- 0.01%
</Table>
5
<Table>
<Caption>
2001 2000 1999
---------- -------- --------
(In thousands)
FRANCHISE FINANCE
New business volume(2).................................... $ 186,164 $236,062 $ 3,768
Total finance assets...................................... 416,833 352,968 213,280
Revenues.................................................. 36,464 28,238 4,975
Nonperforming assets...................................... 3,249 -- 773
Revenues as a percentage of total revenues................ 5.14% 4.09% 1.07%
Ratio of net charge-offs to average finance assets........ 0.96% 0.08% --
MEDIA FINANCE
New business volume....................................... $ 63,541 $107,759 $ 49,870
Total finance assets...................................... 154,298 113,538 49,870
Revenues.................................................. 14,396 9,625 943
Nonperforming assets...................................... -- -- --
Revenues as a percentage of total revenues................ 2.03% 1.39% 0.20%
Ratio of net charge-offs to average finance assets........ -- -- --
</Table>
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(1) Excludes finance receivables of $387 million in 1999 that were purchased in
a business acquisition.
(2) Excludes finance receivables of $226 million in 1999 that were purchased in
a business acquisition.
Structured Capital
Structured Finance -- Textron Financial manages an existing portfolio of
leveraged leases and selectively invests in new leveraged lease transactions.
These transactions involve the long-term lease of real estate and equipment
generally to investment grade lessees. The Company also participates in
investment grade, or near investment grade, structured secured term and
revolving credit facilities and investments in equity partnerships.
Receivables Funding -- Textron Financial provides working capital,
mezzanine financing and other business value financing for small and
medium-sized telecommunication, energy and Internet related technology-driven
companies.
Factoring -- Textron Financial provides accounts receivable (factoring) and
asset-based lending services for small businesses in the trucking industry with
funding needs of $5 million or less, as well as equipment financing and debt
consolidation loans for existing customers.
Finance Company Services -- Textron Financial provides receivable financing
services to small finance companies operating in niche market segments.
The following table sets forth certain financial information regarding the
various businesses included in the Structured Capital segment for the periods
indicated:
<Table>
<Caption>
2001 2000 1999
---------- ---------- --------
(In thousands)
STRUCTURED FINANCE
New business volume..................................... $ 683,882 $ 444,103 $ 91,417
Total finance assets.................................... 798,352 593,971 407,912
Revenues................................................ 74,659 42,870 27,728
Nonperforming assets.................................... 260 -- 100
Revenues as a percentage of total revenues.............. 10.53% 6.21% 5.99%
Ratio of net charge-offs to average finance assets...... -- 0.02% 0.16%
</Table>
6
<Table>
<Caption>
2001 2000 1999
---------- ---------- --------
(In thousands)
RECEIVABLES FUNDING
New business volume(1).................................. $ 400,085 $ 619,133 $241,354
Total finance assets.................................... 156,904 139,474 88,278
Revenues................................................ 25,476 20,439 7,552
Nonperforming assets.................................... 15,306 2,724 --
Revenues as a percentage of total revenues.............. 3.59% 2.96% 1.63%
Ratio of net charge-offs to average finance assets...... 0.91% -- --
FACTORING
New business volume..................................... $1,015,843 $1,059,296 $760,212
Total finance assets.................................... 126,882 110,905 95,303
Revenues................................................ 21,774 19,451 13,955
Nonperforming assets.................................... 2,277 108 --
Revenues as a percentage of total revenues.............. 3.07% 2.82% 3.01%
Ratio of net charge-offs to average finance assets...... 0.92% 0.40% 0.04%
FINANCE COMPANY SERVICES
New business volume(2).................................. $ 242,567 $ 100,263 $ 18,199
Total finance assets.................................... 70,222 64,803 68,165
Revenues................................................ 5,381 9,963 1,401
Nonperforming assets.................................... 16,415 2,644 1,689
Revenues as a percentage of total revenues.............. 0.76% 1.44% 0.30%
Ratio of net charge-offs to average finance assets...... 5.14% 2.94% 0.18%
</Table>
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(1) Excludes finance receivables of $72 million in 1999 that were purchased in a
business acquisition.
(2) Excludes finance receivables of $69 million in 1999 that were purchased in a
business acquisition.
Other
Other -- During 2001, the Company decided to exit certain of its businesses
and product lines. To enhance its competitiveness and profitability, the Company
committed to a plan to restructure a portion of its vendor finance and existing
small business finance operations in the second quarter, and its aircraft
finance and machine tool finance operations in the third quarter. As a result,
the Company recognized charges of $2.7 million, which are shown as special
charges in the Consolidated Statements of Income. In order to manage the orderly
liquidation of the portfolios related to exited businesses and to segregate
their results from its ongoing businesses, the Company has grouped their results
in the Other segment along with the commercial real estate portfolio.
The following table sets forth certain financial information regarding the
various businesses included in the Other segment for the periods indicated:
<Table>
<Caption>
2001 2000 1999
-------- -------- --------
(In thousands)
OTHER
New business volume(1)..................................... $269,315 $428,197 $461,327
Total finance assets....................................... 251,499 647,758 915,810
Revenues................................................... 73,642 74,222 101,163
Nonperforming assets....................................... 44,548 31,820 44,120
Revenues as a percentage of total revenues................. 10.38% 10.75% 21.85%
Ratio of net charge-offs to average finance assets......... 4.81% 2.65% 1.54%
</Table>
- ---------------
(1) Excludes finance receivables of $169 million in 1999 that were purchased in
business acquisitions.
7
COMPETITION
Textron Financial operates in markets which are highly fragmented and
extremely competitive. They are characterized by competitive factors that vary,
to some extent, by product and geographic region. Textron Financial's
competitors include:
- Commercial finance companies;
- National and regional banks and thrift institutions;
- Insurance companies;
- Leasing companies and
- Finance operations of equipment vendors.
Textron Financial competes primarily on the basis of pricing, terms,
structure and service. Competitors often seek to compete aggressively on the
basis of these factors. The Company may lose market share to the extent that it
is unwilling to match competitors' practices. To the extent that Textron
Financial matches these practices, the Company may experience decreased margins,
increased risk of credit losses or both. Many of Textron Financial's competitors
are large companies that have substantial capital, technological and marketing
resources. This has become increasingly the case given the consolidation
activity in the commercial finance industry. In some instances, Textron
Financial's competitors have access to capital at a lower cost than Textron
Financial.
RELATIONSHIP WITH TEXTRON
General
Textron Financial derives a portion of its business from financing the sale
and lease of products manufactured and sold by Textron. In 2001, 2000 and 1999,
Textron Financial paid Textron $1.3 billion, $1.4 billion and $1.3 billion,
respectively, for the purchase of finance receivables and operating lease
equipment. Textron Financial recognized finance charge revenues from Textron and
its affiliates (net of payments or reimbursements for interest charged at more
or less than market rates on Textron manufactured products) of $4.0 million in
2001, $11.6 million in 2000 and $7.2 million in 1999.
Textron Financial and Textron utilize an intercompany account for the
allocation of Textron overhead charges and for the settlement of receivables
purchased by Textron Financial from Textron and its affiliates. For additional
information regarding the relationship between Textron Financial and Textron,
see Notes 4, 5 and 9 to the consolidated financial statements in Item 8 of this
Form 10-K.
Agreements with Textron
Textron Financial and Textron are parties to several agreements which
govern various aspects of the Textron Financial-Textron relationship. They are
described below:
Receivables Purchase Agreement
Under a Receivables Purchase Agreement with Textron, Textron Financial has
recourse to Textron with respect to certain finance receivables and operating
leases relating to products manufactured and sold by Textron. Finance
receivables of $560.9 million at December 29, 2001, and $833.7 million at
December 30, 2000, and operating leases of $90.6 million at December 29, 2001,
and $69.0 million at December 30, 2000, were subject to recourse to Textron or
due from Textron. In addition, Textron Financial had recourse to Textron on
subordinated certificates of $55.8 million and $37.8 million at year-end 2001
and 2000, respectively, and on cash reserve accounts of $13.9 million and $14.4
million at year-end 2001 and 2000, respectively. Both the subordinated
certificates and the cash reserve accounts are retained interests related to
receivable securitizations. Under the Receivables Purchase Agreement, Textron
also makes available to Textron Financial a line of credit of up to $100 million
for junior subordinated borrowings at the prime interest rate.
8
Support Agreement with Textron
Under a Support Agreement with Textron dated as of May 25, 1994, Textron is
required to pay to Textron Financial, quarterly, an amount sufficient to provide
that Textron Financial's pre-tax earnings, before extraordinary items and fixed
charges (including interest on indebtedness and amortization of debt discount
"fixed charges"), will not be less than 125% of the Company's fixed charges. No
such payments under the Support Agreement were required for the years ended
2001, 2000 or 1999, when Textron Financial's fixed-charge coverage ratios (as
defined) were 171%, 158%, and 163%, respectively. Textron also has agreed to
maintain Textron Financial's consolidated shareholder's equity at an amount not
less than $200 million. Pursuant to the terms of the Support Agreement, Textron
is required to directly or indirectly own 100% of Textron Financial's common
stock. The Support Agreement also contains a third-party beneficiary provision
entitling Textron Financial's creditors to enforce its provisions against
Textron.
Tax Sharing Agreement with Textron
Textron Financial's revenues and expenses are included in the consolidated
federal tax return of Textron. The Company files most of its state income tax
returns on a separate basis. Textron Financial is allocated federal tax benefits
and charges on the basis of statutory U.S. tax rates applied to the Company's
taxable income or loss included in the consolidated returns. The benefits of
general business credits, foreign tax credits and any other tax credits are
utilized in computing current tax liability. Textron Financial is paid for tax
benefits generated and utilized in Textron's consolidated federal and state
income tax returns, whether or not the Company would have been able to utilize
those benefits on a separate tax return. Income tax assets or liabilities are
settled on a quarterly basis.
Under a Tax Sharing Agreement with Textron, Textron has agreed to loan to
Textron Financial, on a junior subordinated interest-free basis, an amount equal
to Textron's deferred income tax liability attributable to the manufacturing
profit not yet recognized for tax purposes on products manufactured by Textron
and financed by Textron Financial. Borrowings under this arrangement are
reflected in "Amounts due to Textron Inc." on the Consolidated Balance Sheets in
Item 8 of this Form 10-K.
REGULATIONS
Small Business Act
SBA loans made by Textron Financial are governed by the Small Business Act
and the Small Business Investment Act of 1958, as amended, and also may be
subject to state regulations relating to commercial transactions generally.
These federal and state statutes and regulations specify the types of loans and
loan amounts which are eligible for the SBA guarantee, as well as the servicing
requirements imposed on the lender to maintain the effectiveness of the SBA
guarantee.
Other
Textron Financial's activities are subject, in certain instances, to
supervision and regulation by state and federal governmental authorities. These
activities also may be subject to various laws, including consumer finance laws
in some instances, and judicial and administrative decisions imposing various
requirements and restrictions, which, among other things:
- Regulate credit granting activities;
- Establish maximum interest rates, finance charges and other charges;
- Require disclosures to customers;
- Govern secured transactions;
- Affect insurance brokerage activities and
- Set collection, foreclosure, repossession and claims handling procedures
and other trade practices.
9
Although most states do not intensively regulate commercial finance
activity, many states impose limitations on interest rates and other charges,
and prohibit certain collection and recovery practices. They also may require
licensing of certain business activities and specific disclosure of certain
contract terms. Textron Financial also is required to comply with certain
provisions of the Equal Credit Opportunity Act. The Company also may be subject
to regulation in those foreign countries in which it has operations.
Existing statutes and regulations have not had a material adverse effect on
the Company's business. However, it is not possible to forecast the nature of
future legislation, regulations, judicial decisions, orders or interpretations
or their impact upon Textron Financial's future business, financial condition,
results of operations or prospects.
EMPLOYEES
As of December 29, 2001, Textron Financial had 1,219 employees. The Company
is not subject to any collective bargaining agreements.
RISK MANAGEMENT
Textron Financial's business activities involve various elements of risk.
The Company considers the principal types of risk to be:
- Credit risk;
- Asset/liability risk (including interest rate and foreign exchange risk)
and
- Liquidity risk.
Proper management of these risks is essential to maintaining profitability.
Accordingly, the Company has designed risk management systems and procedures to
identify and quantify these risks. Textron Financial has established appropriate
policies and set prudent limits in these areas. The Company's management of
these risks and levels of compliance with its policies and limits is
continuously monitored by means of administrative and information systems.
Credit Risk Management
Textron Financial manages credit risk through:
- Underwriting procedures;
- Centralized approval of individual transactions exceeding certain size
limits and
- Active portfolio and account management.
The Company has developed underwriting procedures for each operating unit
that assess a prospective customer's ability to perform in accordance with
financing terms. These procedures include:
- Analyzing business or property cash flows and collateral values;
- Performing financing sensitivity analyses and
- Assessing potential exit strategies.
Textron Financial has developed a tiered credit approval system, which
allows certain transaction types and sizes to be approved at the operating unit
level. The delegation of credit authority is done under strict policy
guidelines. Textron Financial operating units are also subject to annual audits
by the Company's Corporate Internal Audit Department.
Depending on transaction size and complexity, transactions outside of
operating unit authority require the approval of a Group President and Group
Investment Control Officer. Transactions exceeding group authority require one
or more of the President and Chief Operating Officer, the Executive Vice
President and Chief Credit Officer, the Chairman and Chief Executive Officer or
Textron Financial's Credit Committee,
10
depending on the size of the transaction. Textron Financial's Credit Committee
is comprised of its Chairman and Chief Executive Officer, President and Chief
Operating Officer, Executive Vice President and Chief Credit Officer, Executive
Vice President and Chief Financial Officer and Executive Vice President, General
Counsel and Secretary.
The Company controls the credit risk associated with its portfolio by
limiting transaction sizes, as well as diversifying transactions by industry,
geographic area, property type and borrower. Through these practices, Textron
Financial identifies and limits exposure to unfavorable risks and seeks
favorable financing opportunities. Management reviews receivable aging trends
and watch list reports and conducts regular business reviews in order to monitor
portfolio performance. Certain receivable transactions are originated with the
intent of fully or partially selling them. This strategy provides an additional
tool to manage credit risk.
Geographic Concentration
Textron Financial continuously monitors its portfolio to avoid any undue
geographic concentration in any region of the U.S. or in any foreign country.
The largest concentration of domestic receivables was in the Southeastern U.S.,
representing 26% of Textron Financial's total owned and securitized portfolio at
December 29, 2001. International receivables are generated mostly in support of
Textron product sales. At December 29, 2001, international receivables
represented 12% of Textron Financial's total owned and securitized portfolio,
with no single country representing more than 4%.
Asset/Liability Risk Management
The Company continuously measures and quantifies interest rate risk,
foreign exchange risk and liquidity risk, in each case taking into account the
effect of derivatives hedging activity. Textron Financial uses derivatives as an
integral part of its asset/liability management program, in order to reduce:
- Interest rate exposure arising from changes in interest rates and
- Foreign currency exposure arising from changes in exchange rates.
The Company does not use derivative financial instruments for the purpose
of generating earnings from changes in market conditions. Before entering into a
derivative transaction, the Company believes that a high correlation exists
between the change in value of the hedged asset or liability and the value of
the derivative. When Textron Financial executes a transaction, it designates the
derivative to a specific asset or liability. The risk that a derivative will
become an ineffective hedge is generally limited to the possibility that an
asset or liability being hedged will prepay before the related derivative
matures. Accordingly, after the inception of a hedge transaction, Textron
Financial monitors the effectiveness of derivatives through an ongoing review of
the amounts and maturities of assets, liabilities and derivative positions. This
information is reviewed by the Company's Senior Vice President and Treasurer and
Executive Vice President and Chief Financial Officer so that appropriate
remedial action can be taken, as necessary.
Textron Financial carefully manages exposure to counterparty risk in
connection with its derivatives transactions. In general, the Company engages in
transactions with counterparties having ratings of at least A by Standard &
Poor's Rating Service or A2 by Moody's Investors Service. Total notional
counterparty exposure is limited to $500 million. This maximum notional exposure
equates to approximately $15 million of potential credit exposure (within two
standard deviations of probability) for the types of derivative transactions
typically entered into by Textron Financial (e.g., interest rate swaps, basis
swaps and short-term currency swaps and forward contracts).
Interest Rate Risk Management
Textron Financial manages interest rate risk by monitoring the duration and
interest rate sensitivities of its assets and by incurring liabilities (either
directly or synthetically with derivatives) having a similar duration and
interest sensitivity profile. The Company's internal policies limit the
aggregate mismatch of interest-sensitive assets and liabilities to 10% of total
assets.
11
From a quantitative perspective, Textron Financial assesses its exposure to
interest rate changes using an analysis that measures the potential loss in net
income, over a twelve-month period, resulting from a hypothetical increase in
interest rates of 100 basis points across all maturities occurring at the outset
of the measurement period (sometimes referred to as a "shock test"). The Company
also assumes in its analysis that prospective receivable additions will be match
funded, existing portfolios will not prepay and all other relevant factors will
remain constant. This shock test model, when applied to Textron Financial's
asset and liability position at December 29, 2001 and December 30, 2000,
indicated no material effect on the Company's net income and cash flows for the
following twelve-month periods, or fair value at December 29, 2001.
Foreign Exchange Risk Management
A small portion of finance assets owned by Textron Financial are located
outside of the United States. These receivables are generally in support of
Textron's overseas product sales and are predominantly denominated in U.S.
dollars. Textron Financial presently has foreign currency receivables
denominated in Canadian, Australian and Euro dollars. In order to minimize the
effect of fluctuations in foreign currency exchange rates on Textron Financial's
financial results, the Company borrows in these currencies and enters into
forward exchange contracts on a monthly basis in amounts sufficient to hedge its
remaining asset exposure. As a result, Textron Financial has no material
exposure to changes in foreign currency exchange rates.
Liquidity Risk Management
The Company uses cash to fund asset growth and to meet debt obligations and
other commitments. Textron Financial's primary sources of funds are:
- Commercial paper borrowings;
- Issuances of medium-term notes and other term debt securities and
- Syndication and securitization of receivables.
All commercial paper borrowings are fully backed by committed lines of
credit, providing liquidity in the event of capital market dislocation. The
Company generally maintains less than one-third of debt obligations in
commercial paper and other short-term debt. If Textron Financial is unable to
access these markets on acceptable terms, the Company can draw on its bank line
of credit facilities and use cash flows from operations and portfolio
liquidations to satisfy its liquidity needs. For additional information
regarding Textron Financial's liquidity risk management, see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources," in Item 7 of this Form 10-K.
PORTFOLIO QUALITY
The performance of Textron Financial's portfolio reflects the Company's
rigorous credit approval process and disciplined portfolio management. At
year-end 2001, nonperforming assets as a percentage of total finance assets was
2.13%.
12
The following table presents information about the credit quality of the
Company's portfolio:
<Table>
<Caption>
2001 2000 1999 1998 1997
------ ------ ------ ----- -----
(In millions)
NONPERFORMING ASSETS
Nonaccrual finance receivables................ $113.8 $101.9 $ 83.6 $69.9 $85.6
Real estate owned............................. 7.5 1.7 8.5 11.6 10.6
Repossessed assets............................ 13.1 7.6 8.8 5.2 3.2
------ ------ ------ ----- -----
Total nonperforming assets............ $134.4 $111.2 $100.9 $86.7 $99.4
====== ====== ====== ===== =====
Ratio of nonaccrual finance receivables to total
receivables................................... 2.0% 1.8% 1.5% 1.9% 2.8%
Ratio of nonperforming assets to total finance
assets........................................ 2.1% 1.9% 1.7% 2.3% 3.1%
ALLOWANCE FOR LOSSES
Allowance for losses on receivables............. $143.8 $116.0 $112.8 $83.9 $77.4
Ratio of allowance for losses on receivables to
receivables................................... 2.6% 2.1% 2.0% 2.3% 2.5%
Ratio of allowance for losses on receivables to
net charge-offs............................... 1.9x 3.1x 4.8x 5.1x 4.0x
Ratio of allowance for losses on receivables to
nonperforming assets.......................... 107.0% 104.3% 111.8% 96.8% 77.9%
</Table>
Nonperforming Assets
Nonperforming assets include nonaccrual finance receivables and repossessed
assets. Textron Financial classifies receivables as nonaccrual and suspends the
recognition of earnings when accounts are contractually delinquent by more than
three months, unless collection of principal and interest is not doubtful. In
addition, earlier suspension may occur if Textron Financial has significant
doubt about the ability of the obligor to meet current contractual terms. Doubt
may be created by payment delinquency, reduction in the obligor's cash flows,
deterioration in the loan to collateral value relationship or other relevant
considerations.
The table below shows nonperforming assets by business segment:
<Table>
<Caption>
YEARS ENDED
--------------------------
2001 2000 1999
------ ------ ------
(In millions)
NONPERFORMING ASSETS BY SEGMENT
Aircraft Finance.......................................... $ 13.1 $ 26.5 $ 11.6
Revolving Credit.......................................... 22.3 35.5 22.0
Specialty Finance......................................... 20.2 11.9 21.4
Structured Capital........................................ 34.3 5.5 1.8
Other..................................................... 44.5 31.8 44.1
------ ------ ------
Total nonperforming assets........................ $134.4 $111.2 $100.9
====== ====== ======
</Table>
The above table does not include captive receivables with recourse to
Textron. Captive receivables with recourse that were 90 days or more delinquent
amounted to 16.0%, 12.6% and 8.9% of recourse captive finance receivables for
the years ended 2001, 2000 and 1999, respectively. Revenues recognized on these
delinquent accounts were approximately $9.5 million, $10.1 million and $7.0
million for the years ended 2001, 2000 and 1999, respectively.
Delinquent Earning Accounts and Loan Modifications
Textron Financial does not have any earning accounts that are 90 days or
more delinquent with the exception of the captive receivables described above.
Loans that are modified are not returned to accruing
13
status until six months of timely payments have been received or Textron
Financial otherwise deems that full collection of principal and interest is not
doubtful.
Allowance for Losses
Provisions for losses on finance receivables are charged to income in
amounts sufficient to maintain the allowance at a level considered adequate to
cover losses in the existing receivable portfolio. Management evaluates the
allowance by examining current delinquencies, the characteristics of the
existing accounts, historical loss experience, the value of the underlying
collateral and general economic conditions and trends.
Finance receivables are charged off when they are deemed uncollectible.
Finance receivables are written down to the fair value (less estimated costs to
sell) of the related collateral at the earlier of the date the collateral is
repossessed or when no payment has been received for six months, unless
management deems the receivable collectible.
Loan Impairment
Textron Financial periodically assesses finance receivables, excluding
homogeneous loan portfolios and finance leases, for impairment. The Company
considers a loan to be impaired if the fair value of the loan is less than its
carrying amount and establishes a reserve based on this difference. Fair value
is based on the present value of expected future cash flows discounted at the
loan's effective interest rate, the loan's observable market price or, if the
loan is collaterally dependent at the fair value of the collateral. This
evaluation is inherently subjective, as it requires estimates including the
amount and timing of future cash flows expected to be received on impaired loans
that may differ from actual results.
ITEM 2. PROPERTIES
Textron Financial leases office space from a Textron affiliate for its
corporate headquarters at 40 Westminster Street, Providence, Rhode Island 02903.
The Company leases other offices throughout the United States. For additional
information regarding Textron Financial's lease obligations, see Note 16 to the
consolidated financial statements in Item 8 of this Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
For information regarding Textron Financial's legal proceedings, see Note
17 to the consolidated financial statements in Item 8 of this Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted per Instruction I of Form 10-K.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of Textron Financial is owned entirely by Textron and,
therefore, there is no trading of Textron Financial's stock. Dividends of $51.1
million were declared and paid in 2001, dividends of $84.3 million were declared
and $82.0 million were paid in 2000, and dividends of $35.7 million were
declared and paid in 1999. For additional information regarding restrictions as
to dividend availability, see Note 9 to the consolidated financial statements in
Item 8 of this Form 10-K.
14
ITEM 6. SELECTED FINANCIAL DATA
The following data should be read in conjunction with Textron Financial's
consolidated financial statements:
<Table>
<Caption>
AT OR FOR THE YEARS ENDED(1)
--------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
RESULTS OF OPERATIONS
Finance charges and discounts........ $ 526,897 $ 587,444 $ 391,091 $ 297,091 $ 290,943
Rental revenues on operating
leases............................. 18,884 18,904 15,503 17,181 18,664
Other income......................... 163,455 84,173 56,309 52,890 40,613
Net income........................... 120,571 118,016 78,904 69,576 67,741
BALANCE SHEET DATA
Total finance receivables............ $5,635,634 $5,589,412 $5,577,374 $3,611,397 $3,069,123
Allowance for losses on
receivables........................ 143,756 115,953 112,769 83,887 77,394
Equipment on operating
leases -- net...................... 201,060 135,356 133,171 118,590 111,518
Total assets......................... 6,463,958 6,130,796 5,989,483 3,784,538 3,177,965
Total short-term debt................ 1,197,707 965,802 1,339,021 1,424,872 1,073,665
Long-term debt....................... 3,500,713 3,701,067 3,211,737 1,403,958 1,290,903
Deferred income taxes................ 357,324 315,322 307,035 321,521 319,293
Textron Financial and Litchfield
obligated mandatory redeemable
preferred securities of trust
subsidiary holding solely
Litchfield junior subordinated
debentures......................... 27,480 28,009 28,539 -- --
Shareholder's equity................. 1,009,355 909,677 869,161 472,452 405,876
Debt to shareholder's equity......... 4.65X 5.13x 5.24x 5.99x 5.83x
SELECTED DATA AND RATIOS
PROFITABILITY
Net interest margin as a percentage
of average net investment(2)....... 7.65% 6.28% 6.27% 6.88% 6.51%
Return on average equity............. 12.7% 13.1% 14.1% 16.2% 16.8%
Return on average assets(3).......... 1.87% 1.88% 1.74% 2.06% 2.07%
Ratio of earnings to fixed charges... 1.71X 1.58x 1.63x 1.72x 1.70x
Selling and administrative expenses
as a percentage of average managed
receivables(4)..................... 1.79% 1.67% 1.75% 1.73% 1.54%
Operating efficiency ratio(5)........ 35.6% 34.1% 35.4% 33.8% 29.3%
CREDIT QUALITY
60+ days contractual delinquency as a
percentage of finance
receivables(6)..................... 2.24% 1.16% 0.96% 0.87% 0.86%
Nonperforming assets as a percentage
of finance assets(7)............... 2.13% 1.86% 1.74% 2.29% 3.10%
Allowance for losses on receivables
as a percentage of finance
receivables........................ 2.55% 2.07% 2.02% 2.32% 2.52%
Net charge-offs as a percentage of
average finance receivables(8)..... 1.27% 0.65% 0.54% 0.45% 0.64%
</Table>
- ---------------
(1) Textron Financial's year-end dates conform with Textron's year-end, which
falls on the nearest Saturday to December 31.
15
(2) Represents revenues earned less interest expense on borrowings as a
percentage of average net investment. Average net investment includes
finance receivables plus operating leases less deferred taxes on leveraged
leases.
(3) Average assets include finance receivables, less allowance for loan losses,
operating leases and other assets. Investments in leveraged leases are not
net of deferred taxes.
(4) Average managed receivables include owned receivables plus receivables
serviced under securitizations, participations and third-party portfolio
servicing agreements.
(5) Operating efficiency ratio is selling and administrative expenses divided by
net interest margin (including other income).
(6) Delinquency excludes captive receivables with recourse to Textron. Captive
receivables represent third-party finance receivables originated in
connection with the sale or lease of Textron manufactured products.
Percentages are expressed as a function of total Textron Financial
independent and nonrecourse captive receivables.
(7) Finance assets include: finance receivables; equipment on operating leases,
net of accumulated depreciation; repossessed assets; retained interests in
securitizations; investment in equipment residuals; ADC arrangements; short
and long-term investments (some of which are classified in Other assets on
Textron Financial's Consolidated Balance Sheets). Nonperforming assets
include independent and nonrecourse captive finance assets.
(8) Excludes net charge-offs recorded against the real estate owned valuation
allowance of $8.0 million and $1.0 million in 2000 and 1997, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL CONDITION
Liquidity and Capital Resources
Textron Financial Corporation (Textron Financial) uses a broad base of
financial resources for its liquidity and capital needs. Cash is provided from
operations and several sources of borrowings, including the issuance of
commercial paper and short-term debt, sales of medium and long-term debt in the
U.S. and foreign financial markets and junior subordinated borrowings under a
$100 million line of credit with Textron Inc. (Textron). For liquidity purposes,
Textron Financial has a policy of maintaining sufficient unused lines of credit
to support its outstanding commercial paper. Textron Financial has bank line of
credit agreements of $1.5 billion of which $500 million will expire in 2002 and
$1.0 billion will expire in 2006. None of these lines of credit were used at
December 29, 2001, or December 30, 2000. Unused lines of credit, including the
$100 million line of credit with Textron, not reserved as support for commercial
paper or a securitization conduit were $975 million at December 29, 2001,
compared to $544 million at December 30, 2000. While the $500 million facility
includes a one year term out option, Textron Financial expects to negotiate and
extend the maturity of the facility in 2002. Textron Financial also maintains a
C$50 million committed Canadian facility under which it can borrow an additional
C$80 million on an uncommitted basis. At December 29, 2001, Textron Financial
has fully used the committed portion of the facility in addition to borrowing
C$63 million under the uncommitted portion of the facility. Textron Financial
also has a $25 million UK facility, of which $15 million remains unused at
year-end 2001. Both the Canadian and UK facilities expire in 2002.
At December 29, 2001, $510 million of Textron Financial's total short-term
debt outstanding represented borrowings under a short-term revolving note
agreement with Textron. This agreement with Textron was the direct result of
Textron's sale of its Automotive Trim division at year-end and the availability
of the resulting cash proceeds. In lieu of investing in other investment grade,
short-term debt securities, Textron and Textron Financial concluded it was most
effective for Textron to invest in Textron Financial's short-term obligations.
This arrangement was structured through the revolving note agreement instead of
buying Textron Financial's commercial paper in the marketplace. At January 24,
2002, Textron Financial had paid off its obligation and terminated this
agreement.
16
Under a shelf registration statement filed with the Securities and Exchange
Commission, Textron Financial may issue public debt securities in one or more
offerings up to a total maximum offering of $3 billion. At December 29, 2001,
Textron Financial had $3 billion available under this facility. In the year
ended December 29, 2001, Textron Financial issued $550 million of floating rate
notes and $300 million of fixed rate notes under a previous shelf registration
statement that mature in 2003 and 2004, respectively. The proceeds from these
issuances were used to refinance maturing commercial paper and long-term debt at
par.
Through a private issuance in 2001, Textron Financial also entered into a
$50 million variable rate note maturing in 2003.
At December 29, 2001, Textron Financial had principal payments due on
long-term debt of $1.6 billion, $1.0 billion and $0.9 billion in 2002, 2003 and
2004, respectively.
At December 29, 2001, Textron Financial had unused commitments to fund new
and existing customers under $1.3 billion of committed revolving lines of credit
and uncommitted revolving lines of credit of $599 million. Since many of the
agreements will not be used to the extent committed or will expire unused, the
total commitment amount does not necessarily represent future cash requirements.
During the year, Textron Financial received proceeds from securitizations
of $625 million of floorplan finance receivables (on a revolving basis), $309
million of aircraft finance receivables, $198 million of captive golf and turf
finance receivables, $90 million of franchise finance receivables, $56 million
of land finance receivables and $19 million of resort receivables. These
securitizations provided Textron Financial with an alternate source of funding
while maintaining desired debt-to-capital ratios. Textron Financial used the
proceeds from the securitizations to retire commercial paper. Textron Financial
anticipates that it will enter into additional securitization transactions in
2002.
In addition, Textron Financial received $311 million of proceeds from the
sale of an equipment portfolio to a third-party. In connection with this sale,
Textron Financial retained a contingent recourse liability of $32 million. In
the event Textron Financial's credit rating drops below a low BBB, it is
required to pledge related equipment residuals of $14 million and cover any
remaining unsecured contingent liability with a letter of credit up to $18
million.
During the fourth quarter of 2001, certain of Textron Financial's
commercial paper and long-term debt credit ratings were downgraded. Although
Textron Financial's borrowing spreads have increased as a result of the
downgrades, Textron Financial has not experienced any change in its access to
the commercial paper and securitization markets. Further downgrades in Textron
Financial's ratings could increase borrowing spreads or limit its access to the
commercial paper, securitization and long-term debt markets. In addition,
Textron Financial's $1.5 billion revolving bank line of credit agreements
contain certain financial covenants that Textron Financial needs to comply with
to maintain its ability to borrow under the facilities. Textron Financial was in
full compliance with such covenants at December 29, 2001.
Textron Financial believes that it has adequate credit facilities and
access to credit markets to meet its long-term financing needs.
Cash flows provided by operations were $282 million in 2001, compared to
$163 million in 2000. The increase is primarily due to a 31% increase in net
income before depreciation and amortization and provision for losses, as well as
increases due to the timing of payments of income taxes and accrued interest and
other liabilities, partially offset by noncash gains on securitizations and an
increase in other assets. Cash flows from operations were $163 million in 2000,
compared to $144 million in 1999. The increase is primarily due to a 43%
increase in net income before depreciation and amortization and provision for
losses as well as an increase due to the timing of income tax payments,
partially offset by decreases due to the timing of payments of accrued interest
and other liabilities and noncash gains on securitizations.
Cash flows used in investing activities in 2001 and 2000 were funded from
the collection of receivables, the syndication and securitization of receivables
and through the issuance of debt.
In 2001, the $232 million increase in short-term debt was mostly offset by
the $200 million decrease in long-term debt. The $32 million net increase in
short and long-term debt combined with the $75 million
17
increase in nonrecourse debt provided a portion of the cash used in investing
activities. In 2000, the $489 million increase in long-term debt was mostly
offset by the $373 million decrease in short-term debt. The $116 million net
increase in short and long-term debt as well as the $48 million increase in
nonrecourse debt also provided a portion of the cash used in investing
activities.
Because the finance business involves the purchase and carrying of
receivables, a relatively high ratio of borrowings to net worth is customary.
Debt as a percentage of total capitalization was 82% at December 29, 2001,
compared to 84% at the end of 2000. Textron Financial's ratio of earnings to
fixed charges was 1.71x in 2001 (1.58x in 2000 and 1.63x in 1999). Commercial
paper and Other short-term debt as a percentage of total debt was 25% at
December 29, 2001, compared to 21% at the end of 2000. Relative changes in short
and long-term debt primarily depend on matching the duration of assets and
liabilities.
In 2001, Textron Financial declared and paid dividends to Textron of $51.1
million, compared to dividends declared of $84.3 million and dividends paid of
$82.0 million in 2000. The decrease in 2001 was due to the retention of capital
to support receivable and other asset growth. Textron contributed capital of
$49.0 million to Textron Financial in 2001, primarily to support the acquisition
of a small business lending portfolio in June 2001. The 2000 capital
contribution of $31.8 million ($27.3 million noncash and $4.5 million cash)
consisted of Textron's contribution of Textron Funding Corporation, whose only
asset is 1,522 shares of Textron Inc. Series D cumulative preferred stock,
bearing an annual dividend yield of 5.92%.
Finance Assets
Textron Financial's portfolio includes a wide variety of loans and leases,
almost entirely on a secured basis, to customers located primarily in the United
States. Management believes that the portfolio avoids excessive concentration of
risk through diversification across geographic regions, industries and types of
collateral and among borrowers.
Total finance assets were $6.3 billion at December 29, 2001, up 5% from
$6.0 billion at December 30, 2000. The increase in finance assets was mostly due
to portfolio growth in the Specialty Finance ($370 million), Structured Capital
($243 million) and Aircraft Finance ($159 million) segments offset by a decrease
in finance assets in the Other segment ($396 million). The finance assets of the
Specialty Finance, Aircraft Finance and Revolving Credit segments grew $720
million, $468 million and $582 million before consideration of the net change in
finance assets from securitizations of $350 million, $309 million and $619
million, respectively.
Organic growth in the resort receivables, golf finance and franchise
finance businesses provided most of the growth in the Specialty Finance segment,
while Cessna finance and the syndicated bank loan businesses provided most of
the organic growth in the Aircraft Finance and Structured Capital segments,
respectively. Organic growth in the dealer floorplan finance business combined
with the acquisition of a $401 million small business portfolio provided the
majority of the growth in the Revolving Credit segment before consideration of
floorplan securitizations through a revolving conduit. During 2001, Textron
Financial decided to exit certain of its businesses and product lines and has
segregated their results in the Other segment. The decrease in finance assets in
the Other segment reflects the orderly liquidation of these portfolios.
Nonperforming Assets
Nonperforming assets, which includes independent and nonrecourse captive
finance assets, as a percentage of finance assets increased to 2.13% at December
29, 2001, from 1.86% at December 30, 2000, primarily due to the softening of the
economy. Nonperforming assets were $134 million at December 29, 2001, compared
to $111 million at December 30, 2000. The 2001 increase in nonperforming assets
was largely attributable to the Structured Capital (finance company services and
factoring) and Revolving Credit (dealer floorplan financing) segments, partially
offset by a decrease in Aircraft Finance and Other (commercial lending and real
estate) segments. The allowance for losses on receivables as a percentage of
nonperforming assets increased to 107% at December 29, 2001, compared to 104% at
December 30, 2000.
18
Interest Rate Sensitivity
Textron Financial's mix of fixed and floating rate debt is continuously
monitored by management and is adjusted, as necessary, based on evaluations of
internal and external factors.
Management's strategy of matching interest-sensitive assets with
interest-sensitive liabilities limits Textron Financial's risk to changes in
interest rates and includes entering into interest rate exchange agreements as
part of this matching strategy. At December 29, 2001, interest-sensitive assets
in excess of interest-sensitive liabilities were $410 million, net of $370
million of interest rate exchange agreements on long-term debt and $97 million
of interest rate exchange agreements on finance receivables. Interest-sensitive
assets in excess of interest-sensitive liabilities were $415 million at December
30, 2000, net of $150 million of interest rate exchange agreements on Textron
Financial's debt and $100 million of interest rate exchange agreements on
finance receivables. The change in Textron Financial's net position does not
reflect a change in management's match funding strategy.
Management believes that its asset management policy provides adequate
protection against interest rate risks. Increases in interest rates, however,
could have an adverse effect on interest margin. Variable rate receivables are
generally tied to changes in the prime rate offered by major U.S. banks or
LIBOR. Increases in short-term borrowing costs generally precede increases in
variable rate receivable yields. From a quantitative perspective, Textron
Financial assesses its exposure to interest rate changes using an analysis that
measures the potential loss in net income, over a twelve-month period, resulting
from a hypothetical increase in interest rates of 100 basis points across all
maturities occurring at the outset of the measurement period (sometimes referred
to as a "shock test"). Textron Financial also assumes in its analysis that
prospective receivable additions will be match funded, existing portfolios will
not prepay and all other relevant factors will remain constant. This shock test
model, when applied to Textron Financial's asset and liability position at
December 29, 2001 and December 30, 2000, indicated no material effect on Textron
Financial's net income and cash flows for the following twelve-month periods, or
fair value at December 29, 2001.
Financial Risk Management
Textron Financial's results are affected by changes in U.S. and, to a
lesser extent, foreign interest rates. As part of managing this risk, Textron
Financial enters into interest rate exchange agreements. Textron Financial's
objective of entering into such agreements is not to speculate for profit, but
generally to convert variable rate debt into fixed rate debt and vice versa. The
overall objective of Textron Financial's interest rate risk management is to
achieve a prudent balance between floating and fixed rate debt. These agreements
do not involve a high degree of complexity or risk. The net effect of these
agreements decreased interest expense by $1.2 million in 2001, was insignificant
in 2000 and increased interest expense by $1.8 million in 1999. Certain interest
rate exchange agreements require Textron Financial to cover any out of the money
positions with cash payments or letters of credit if its credit ratings drop
below a certain level ranging from middle BBB to low BBB. While Textron
Financial's ratings were not below such levels at December 29, 2001, those out
of the money positions totaled $23 million and are included in the Consolidated
Balance Sheets.
Textron Financial manages its foreign currency exposure by funding most
foreign currency denominated assets with liabilities in the same currency. In
addition, as part of managing its foreign currency exposure, Textron Financial
may enter into foreign currency forward exchange contracts. The objective of
such agreements is to manage any remaining exposure to changes in currency
rates. The notional amounts of outstanding foreign currency forward exchange
contracts in 2001 and 2000 were insignificant.
CRITICAL ACCOUNTING POLICIES
Derivatives
Textron Financial holds derivative financial instruments such as interest
rate and foreign exchange agreements to mitigate its exposure to changes in
interest and foreign exchange rates associated with certain finance receivables,
retained interests in securitizations and long-term debt. These derivatives
qualify for hedge accounting as discussed in detail in Notes 1 and 10 to the
consolidated financial statements. As
19
previously mentioned, Textron Financial does not trade derivatives for
speculative purposes. Textron Financial expects its derivatives to continue to
qualify for hedge accounting. However, should circumstances arise that preclude
hedge accounting, the changes in fair value of the derivatives will be reflected
in earnings.
Textron Financial determines the fair value of the derivatives based on
market values provided by independent parties. Certain market values are based
on estimated cash flows developed by Textron Financial that may include
assumptions about estimated prepayment rates of the hedged assets. The values of
these derivatives may change over time as payments are made, market conditions
change and actual prepayment rates differ from estimated rates. For information
about the fair value of these agreements, see Note 15 to the consolidated
financial statements.
While these agreements expose Textron Financial to credit losses in the
event of nonperformance by counterparties to the agreements, Textron Financial
minimizes the risk of nonperformance by only entering into contracts with
financially sound counterparties with long-term bond ratings of middle A or
higher, by continuously monitoring such credit ratings and by limiting its
exposure with any one financial institution. Textron Financial had minimal
exposure to loss from nonperformance by the counterparties to these agreements
at the end of 2001.
Securitized Transactions
Securitizations are an important source of funding ($1.3 billion in 2001),
and represent a significant portion of Textron Financial's revenues and income
before income taxes and distributions on preferred securities (3.7% and 13.6%,
respectively, in 2001, excluding the revolving floorplan conduit). Securitized
transactions involve the periodic transfer of finance receivables to off balance
sheet trusts. At December 29, 2001, the outstanding balance of such transferred
assets was $2.3 billion. Textron Financial may retain an interest in the
transferred assets in the form of interest-only securities, subordinated
certificates, cash reserve accounts and servicing rights and obligations.
Textron Financial continues to be exposed to the credit risk inherent in the
securitized receivables because it provided credit enhancement to third-party
investors through its retained interests in the securitization trusts. See Notes
1 and 6 to the consolidated financial statements for a discussion of policies
concerning the valuation and impairment of retained interests as well as the
assumptions used in valuing these interests.
Textron Financial does not provide legal recourse to third-party investors
that purchase interests in Textron Financial's securitizations beyond the credit
enhancement inherent in the retained interest-only securities, subordinated
certificates and cash reserve accounts. As of December 29, 2001, the underlying
collateral in Textron Financial's securitizations continues to perform as
expected at the time of the securitizations. Consequently, Textron Financial
believes that its retained interests on the securitizations continue to provide
the credit enhancement anticipated at the time of the securitizations. Textron
Financial also believes that it is unlikely that the performance of the
underlying collateral will deteriorate to a level where the credit enhancement
provided by the retained interests will be materially impaired.
Allowance for Losses on Receivables
Management evaluates its allowance for losses on receivables based on a
combination of factors. For its homogeneous loan pools, Textron Financial
examines current delinquencies, the characteristics of the existing accounts,
historical loss experience, the value of the underlying collateral and general
economic conditions and trends. Textron Financial estimates losses will range
from 0.5% to 5.6% of finance receivables depending on the specific homogeneous
loan pool. The range of estimated losses is consistent with prior periods. For
larger balance commercial loans, Textron Financial considers borrower specific
information, industry trends and estimated discounted cash flows, as well as the
factors described above for homogeneous loan pools.
20
RESULTS OF OPERATIONS
2001 VS. 2000
Revenues
Revenues for the twelve months ended December 29, 2001, increased by $18.7
million or 2.7% reflecting increased other income partially offset by lower
yields on finance receivables. Finance charges and discounts decreased by $60.5
million or 10.3% reflecting a decrease in portfolio yield to 9.40% from 10.59%
in 2000, partially offset by a 1.1% higher level of average finance receivables.
The lower yields reflect a decrease in the interest rate environment in 2001
compared to the corresponding period in 2000. The increase in other income is
due mostly to higher securitization gains, syndication gains, investment income,
servicing fees and a nonrecurring prepayment gain of $14.3 million in 2001.
Operating lease revenue decreased slightly despite a small increase in average
operating lease assets.
Interest Expense
Interest expense for the twelve months ended December 29, 2001, decreased
by $63.5 million or 19.1% primarily as the result of a decrease in the average
borrowing rate for the period from 6.89% to 5.49%, attributable to a lower
interest rate environment, partially offset by higher average debt outstanding.
Interest Margin
Interest margin as a percentage of average net investment for the twelve
months of 2001 increased to 7.65% from 6.28% for the corresponding period in
2000 primarily due to higher gains on securitizations, investment income and
other income.
Operating Expenses
Selling and administrative expenses for the twelve months of 2001 increased
by $34.7 million, compared to the corresponding period in 2000. Selling and
administrative expenses as a percentage of average managed receivables increased
to 1.79% for the twelve months of 2001 from 1.67% for the corresponding period
in 2000 principally reflects higher expenses related to growth in managed
receivables, new business initiatives and higher legal and collection expenses.
Provision for Losses
The provision for losses of $81.7 million was $45.0 million higher than the
corresponding period in 2000. Net charge-offs were $74.4 million during 2001,
compared to $45.8 million in 2000, which included an $8.0 million charge-off to
the real estate owned valuation allowance. The increase in the provision for
losses primarily reflects the softening of the economy and the resulting
increase in net charge-offs, primarily in the Revolving Credit segment's small
business portfolio and charge-offs in liquidating portfolios in the Other
segment.
The allowance for losses on receivables increased to $144 million at
December 29, 2001, compared to $116 million at December 30, 2000. The allowance
for losses on receivables as a percentage of total finance receivables was 2.6%
at December 29, 2001, compared to 2.1% at December 30, 2000 (2.8% in 2001 and
2.4% in 2000, excluding captive receivables with recourse to Textron). The
allowance for losses on receivables as a percentage of nonperforming assets was
107% at December 29, 2001, compared to 104% at December 30, 2000.
Although management believes it has made adequate provision for anticipated
losses, realization of these assets remains subject to uncertainties. Subsequent
evaluations of nonperforming assets, in light of factors then prevailing,
including economic conditions, may require additional increases in the allowance
for losses for such assets.
21
Operating Results by Segment
Specialty Finance income before special charges, income taxes and
distributions on preferred securities decreased by $1.9 million due to lower
interest margin, higher operating expenses and the inclusion of a gain on sale
of real estate owned recorded in 2000, partially offset by higher average
finance assets of $228 million.
Revolving Credit income before special charges, income taxes and
distributions on preferred securities increased by $26.6 million due to higher
interest margin, including higher securitization gains and a 52% growth in
managed receivables, partially offset by higher operating expenses, principally
in floorplan finance and technology finance and higher net charge-offs. Lower
average finance assets reflect a $619 million securitization of floorplan
finance receivables on a revolving basis.
Structured Capital income before special charges, income taxes and
distributions on preferred securities increased by $22.0 million reflecting
higher average finance assets of $240 million, primarily related to syndicated
bank loans and receivables funding and a prepayment gain of $14.3 million,
partially offset by higher operating expenses and a higher provision for losses.
Aircraft Finance income before special charges, income taxes and
distributions on preferred securities decreased by $15.6 million reflecting $192
million lower average finance assets, lower interest margin and higher net
charge-offs.
Special Charges
To enhance its competitiveness and profitability, Textron Financial
committed to a plan to restructure its vendor finance and existing small
business finance operations, in the second quarter and its aircraft finance and
machine tool finance operations in the third quarter. As a result, Textron
Financial recognized charges of $2.7 million for the year ended December 29,
2001, terminated 155 employees and closed two facilities. The restructuring
charges related to employee terminations include the cost of severance related
benefits based on established policies and practices. As of December 29, 2001,
Textron Financial has paid severance related benefits and other expenses of $1.8
million, which have been charged against the restructuring reserve, leaving a
balance in the reserve of $0.9 million. Textron Financial expects to pay the
remaining restructuring costs by August 2002. In order to manage the orderly
liquidation of the portfolios related to exited businesses and to segregate
their results from its ongoing businesses, Textron Financial grouped their
results in the Other segment.
Net Income
Net income for the twelve months of 2001 of $120.6 million was $2.6 million
or 2.2% higher than the corresponding period in 2000. The favorable results were
due to higher average finance assets, higher fee income and a lower effective
tax rate, partially offset by higher selling and administrative expenses, a
higher loss provision and special charges.
RESULTS OF OPERATIONS
2000 VS. 1999
Revenues
Revenues for the twelve months ended December 30, 2000, increased by $227.6
million or 49.2% reflecting a higher level of average finance receivables,
higher yields on finance receivables, an increase in other income and a higher
level of average operating lease assets. Finance charges and discounts increased
by $196.4 million or 50.2% reflecting a 38.1% higher level of average finance
receivables and an increase in portfolio yield to 10.59% from 9.73% in 1999.
Acquisitions completed in 1999 accounted for $122.3 million of the revenue
increase. The higher yields reflect an increase in the interest rate environment
in 2000 compared to the corresponding period in 1999. The increase in other
income is due mostly to syndication and securitization income partially offset
by the sale of an investment in 1999. Operating lease revenue increased $3.4
million due to higher average operating lease assets.
22
Interest Expense
Interest expense for the twelve months ended December 30, 2000, increased
by $128.0 million or 62.8% on 40.6% higher average debt outstanding. The higher
interest expense also reflected an increase in the average borrowing rate for
the period from 5.92% to 6.89% attributable to a higher interest rate
environment and a reduction in short-term debt as a percentage of total debt.
Interest Margin
Interest margin for the twelve months of 2000 was essentially unchanged at
6.28%, compared to 6.27% for the corresponding period in 1999. The 2000 interest
margin included higher fee income relative to average outstanding receivables,
offset by lower leveraged lease earnings.
Operating Expenses
Selling and administrative expenses for the twelve months of 2000 increased
by $29.9 million, compared to the corresponding period in 1999. The increase in
2000 principally reflects the full year impact of Textron Financial's 1999
acquisitions. Selling and administrative expenses as a percentage of average
managed receivables decreased to 1.67% for the twelve months of 2000 from 1.75%
for the corresponding period in 1999.
Provision for Losses
The provision for losses of $36.7 million was $4.6 million higher than the
corresponding period in 1999. Net charge-offs were $45.8 million during 2000,
compared to $23.6 million in 1999. The increase in net charge-offs reflects
$12.6 million for real estate accounts that were fully reserved (including an
$8.0 million charge-off to the real estate owned valuation allowance) compared
to $2.2 million that were recognized in the corresponding period in 1999. The
net increase in 2000 also reflects higher net charge-offs, primarily land
finance, of $5.2 million. Textron Financial also experienced an increase in net
charge-offs in 2000, compared to 1999 of $3.9 million in its Revolving Credit
segment, primarily asset-based lending and dealer floorplan financing and $2.3
million in an equipment leasing portfolio within the Other segment.
The allowance for losses on receivables increased to $116 million at
December 30, 2000, compared to $113 million at January 1, 2000. The allowance
for losses on receivables as a percentage of total finance receivables was 2.1%
at December 30, 2000, compared to 2.0% at January 1, 2000 (2.4% in 2000 and
1999, excluding captive receivables with recourse to Textron). The allowance for
losses on receivables as a percentage of nonperforming assets was 104% at
December 30, 2000, compared to 112% at January 1, 2000.
Operating Results by Segment
Specialty Finance income before income taxes and distributions on preferred
securities increased $42.8 million due to $869 million higher average finance
assets and higher interest margins, partially offset by higher operating
expenses. An acquisition completed in the last quarter of 1999 accounted for
$17.9 million of the increase in income.
Revolving Credit income before income taxes and distributions on preferred
securities decreased by $2.6 million despite $257 million higher average finance
assets and a higher interest margin due to higher charge-offs and a lower
interest margin in the asset-based lending portfolio.
Structured Capital income before income taxes and distributions on
preferred securities increased $11.3 million due to $280 million higher average
finance assets and higher interest margins, partially offset by higher operating
expenses. Acquisitions completed in 1999 accounted for $3.5 million of the
increase in income.
Aircraft Finance income before income taxes and distributions on preferred
securities increased $18.4 million due to higher average finance assets of $316
million, higher average operating lease assets, higher yields on finance
receivables and an increase in securitization income, partially offset by higher
operating expenses.
23
Net Income
Net income for the twelve months of 2000 of $118.0 million was $39.1
million or 50% higher than the corresponding period in 1999. The favorable
results were due to higher average finance assets, higher fee income, higher
rental revenues on higher average operating lease assets and a lower effective
tax rate, partially offset by higher selling and administrative expenses, higher
goodwill amortization and a higher loss provision.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations," and No. 142, "Goodwill and Other Intangible Assets," effective
for fiscal years beginning after December 15, 2001. Under the new rules,
goodwill, along with intangible assets deemed to have indefinite lives, will no
longer be amortized but will be subject to annual impairment tests in accordance
with the Statements. Also, business combinations initiated after June 30, 2001,
must be accounted for using the purchase method accounting.
Textron Financial will apply the new rules on accounting for goodwill and
other intangible assets beginning in the first quarter of 2002. Application of
the nonamortization provisions of the Statement would have resulted in an
increase in net income of $11.2 million. During 2002, Textron Financial will
perform the first of the required impairment tests of goodwill and indefinite
lived intangible assets as of December 30, 2001, and has not yet determined what
the effect of these tests will be on its results of operations and financial
position.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment and Disposal of Long-Lived Assets." SFAS No. 144 requires that one
accounting model be used for long-lived assets to be disposed of by sale.
Discontinued operations will be measured similar to other long-lived assets
classified as held for sale at the lower of its carrying amount or fair value
less cost to sell. Future operating losses will no longer be recognized as they
occur. SFAS No. 144 also broadens the presentation of discontinued operations to
include a component of an entity when operations and cash flows can be clearly
distinguished, and is effective for financial statements issued for fiscal years
beginning after December 15, 2001. At this time, the adoption of this Statement
is not expected to have a material effect on Textron Financial's results of
operations or financial position.
Forward-looking Statements
Certain statements in this Annual Report and other oral and written
statements made by Textron Financial from time to time, are forward-looking
statements, including those that discuss strategies, goals, outlook or other
nonhistorical matters; or project revenues, income, returns or other financial
measures. These forward-looking statements are subject to risks and
uncertainties that may cause actual results to differ materially from those
contained in the statements, including the following: (a) the extent to which
Textron Financial is able to successfully integrate acquisitions; (b) changes in
worldwide economic and political conditions and associated impact on interest
and foreign exchange rates; (c) the level of sales of Textron products for which
Textron Financial offers financing; (d) the ability to maintain credit quality
and control costs when entering new markets; (e) the actions of our competitors
and our ability to respond; (f) our ability to attract and retain qualified and
experienced personnel; (g) Textron Financial's access to debt financing at
competitive rates; and (h) access to equity in the form of retained earnings and
capital contributions from Textron.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
For information regarding Textron Financial's Quantitative and Qualitative
Disclosure about Market Risk, see "Risk Management" in Item 1 of this Form 10-K.
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Textron Financial Corporation
We have audited the accompanying consolidated balance sheets of Textron
Financial Corporation as of December 29, 2001 and December 30, 2000, and the
related consolidated statements of income, cash flows, and changes in
shareholder's equity for each of the three years in the period ended December
29, 2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Textron
Financial Corporation at December 29, 2001 and December 30, 2000, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 29, 2001, in conformity with accounting
principles generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, in 2001
the Company adopted SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities."
/s/ Ernst & Young LLP
Boston, Massachusetts
January 24, 2002
25
CONSOLIDATED STATEMENTS OF INCOME
For each of the three years in the period ended December 29, 2001
<Table>
<Caption>
2001 2000 1999
-------- -------- --------
(In thousands)
REVENUES
Finance charges and discounts.............................. $526,897 $587,444 $391,091
Rental revenues on operating leases........................ 18,884 18,904 15,503
Other income............................................... 163,455 84,173 56,309
-------- -------- --------
709,236 690,521 462,903
EXPENSES
Interest................................................... 268,358 331,865 203,817
Selling and administrative................................. 156,207 121,534 91,620
Provision for losses....................................... 81,679 36,704 32,067
Depreciation of equipment on operating leases.............. 7,861 8,422 6,867
Special charges............................................ 2,686 -- --
-------- -------- --------
516,791 498,525 334,371
-------- -------- --------
INCOME BEFORE INCOME TAXES AND DISTRIBUTIONS ON PREFERRED
SECURITIES............................................... 192,445 191,996 128,532
Income taxes............................................... 70,439 72,585 49,385
Distributions on preferred securities (net of tax benefits
of $810, $837 and $153, respectively).................... 1,435 1,395 243
-------- -------- --------
NET INCOME................................................. $120,571 $118,016 $ 78,904
======== ======== ========
</Table>
See notes to consolidated financial statements.
26
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 29, DECEMBER 30,
2001 2000
------------ ------------
(Dollars in thousands)
ASSETS
Cash and equivalents........................................ $ 18,489 $ 6,498
Finance receivables, net of unearned income:
Installment contracts..................................... 2,047,088 1,985,304
Revolving loans........................................... 1,578,922 1,304,591
Golf course and resort mortgages.......................... 811,534 678,409
Floorplan receivables..................................... 474,391 894,037
Leveraged leases.......................................... 404,423 360,982
Finance leases............................................ 318,859 360,639
Commercial real estate mortgages.......................... 417 5,450
---------- ----------
Total finance receivables......................... 5,635,634 5,589,412
Allowance for losses on receivables....................... (143,756) (115,953)
---------- ----------
Finance receivables -- net........................ 5,491,878 5,473,459
Goodwill -- net............................................. 203,564 215,608
Equipment on operating leases -- net........................ 201,060 135,356
Other assets................................................ 548,967 299,875
---------- ----------
Total assets...................................... $6,463,958 $6,130,796
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
LIABILITIES
Accrued interest and other liabilities...................... $ 341,394 $ 190,921
Amounts due to Textron Inc.................................. 29,985 19,998
Deferred income taxes....................................... 357,324 315,322
Note payable to Textron Inc................................. 510,000 --
Other debt.................................................. 4,188,420 4,666,869
---------- ----------
Total liabilities................................. 5,427,123 5,193,110
---------- ----------
Textron Financial and Litchfield obligated mandatory
redeemable preferred securities of trust subsidiary
holding solely Litchfield junior subordinated
debentures................................................ 27,480 28,009
SHAREHOLDER'S EQUITY
Common stock, $100 par value (4,000 shares authorized; 2,500
shares issued and outstanding)............................ 250 250
Capital surplus............................................. 573,676 533,676
Investment in parent company preferred stock................ (25,000) (25,000)
Accumulated other comprehensive loss........................ (18,793) --
Retained earnings........................................... 479,222 400,751
---------- ----------
Total shareholder's equity........................ 1,009,355 909,677
---------- ----------
Total liabilities and shareholder's equity........ $6,463,958 $6,130,796
========== ==========
</Table>
See notes to consolidated financial statements.
27
CONSOLIDATED STATEMENTS OF CASH FLOWS
For each of the three years in the period ended December 29, 2001
<Table>
<Caption>
2001 2000 1999
----------- ----------- -----------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................... $ 120,571 $ 118,016 $ 78,904
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for losses........................... 81,679 36,704 32,067
Increase (decrease) in accrued interest and
other liabilities.............................. 46,752 (23,799) 28,249
Deferred income tax provision..................... 46,335 16,109 (4,558)
Amortization...................................... 21,828 15,265 7,362
Depreciation...................................... 19,326 16,507 12,055
Leveraged lease noncash earnings.................. -- -- (3,588)
Gain on sale of investment........................ -- -- (4,710)
Gain on sale of real estate owned................. -- (1,875) --
Gains on securitizations.......................... (42,799) (22,053) --
Other............................................. (11,301) 7,845 (1,807)
----------- ----------- -----------
Net cash provided by operating
activities.............................. 282,391 162,719 143,974
CASH FLOWS FROM INVESTING ACTIVITIES:
Finance receivables originated or purchased......... (7,614,226) (7,032,392) (4,920,185)
Finance receivables repaid.......................... 5,750,364 5,233,584 3,783,080
Proceeds from receivable sales, including
securitizations................................... 2,018,689 1,555,790 307,140
Acquisitions, net of cash acquired.................. (387,594) -- (714,942)
Purchase of assets for operating leases............. (85,444) (50,326) (62,579)
Proceeds from disposition of operating leases and
other assets...................................... 13,014 40,519 43,737
Net proceeds from sale of investment................ -- -- 4,501
Other capital expenditures.......................... (17,506) (14,406) (11,025)
Proceeds from real estate owned..................... 183 8,593 3,503
Other investments................................... (62,581) (3,356) (10,053)
----------- ----------- -----------
Net cash used in investing activities..... (385,101) (261,994) (1,576,823)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt............ 896,872 1,287,450 2,345,013
Principal payments on long-term debt................ (1,097,226) (798,120) (1,056,392)
Net decrease in commercial paper.................... (332,560) (48,388) (181,391)
Net increase (decrease) in other short-term debt.... 564,465 (324,831) 95,540
Proceeds from issuance of nonrecourse debt.......... 276,118 200,989 51,286
Principal payments on nonrecourse debt.............. (200,855) (153,139) (143,675)
Net increase (decrease) in amounts due to Textron
Inc............................................... 9,987 1,933 (354)
Capital contributions from Textron Inc.............. 49,010 4,504 353,505
Dividends paid to Textron Inc. ..................... (51,110) (82,004) (35,700)
----------- ----------- -----------
Net cash provided by financing
activities.............................. 114,701 88,394 1,427,832
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH..................... 11,991 (10,881) (5,017)
Cash and equivalents at beginning of year........... 6,498 17,379 22,396
----------- ----------- -----------
Cash and equivalents at end of year................. $ 18,489 $ 6,498 $ 17,379
=========== =========== ===========
</Table>
See notes to consolidated financial statements.
28
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
For each of the three years in the period ended December 29, 2001
<Table>
<Caption>
ACCUMULATED
INVESTMENT IN OTHER
COMMON CAPITAL PARENT COMPANY COMPREHENSIVE RETAINED
STOCK SURPLUS PREFERRED STOCK LOSS EARNINGS TOTAL
------ -------- --------------- ------------- -------- ----------
(In thousands)
BALANCE JANUARY 2, 1999... $250 $155,171 -- -- $317,031 $ 472,452
Net income................ -- -- -- -- 78,904 78,904
Capital contributions from
Textron Inc. ........... -- 353,505 -- -- -- 353,505
Dividends to Textron
Inc. ................... -- -- -- -- (35,700) (35,700)
---- -------- -------- -------- -------- ----------
BALANCE JANUARY 1, 2000... 250 508,676 -- -- 360,235 869,161
Net income................ -- -- -- -- 118,016 118,016
Capital contributions from
Textron Inc. ........... -- 31,757 $(25,000) -- -- 6,757
Dividends to Textron
Inc. ................... -- (6,757) -- -- (77,500) (84,257)
---- -------- -------- -------- -------- ----------
BALANCE DECEMBER 30,
2000.................... 250 533,676 (25,000) -- 400,751 909,677
COMPREHENSIVE INCOME:
NET INCOME.............. -- -- -- -- 120,571 120,571
OTHER COMPREHENSIVE
INCOME, NET OF INCOME
TAXES:
UNREALIZED NET LOSSES
ON HEDGE
CONTRACTS.......... -- -- -- $(19,359) -- (19,359)
UNREALIZED NET GAINS
ON INTEREST-ONLY
SECURITIES......... -- -- -- 566 -- 566
-------- ----------
OTHER COMPREHENSIVE
LOSS................. -- -- -- (18,793) -- (18,793)
----------
COMPREHENSIVE INCOME...... -- -- -- -- -- 101,778
CAPITAL CONTRIBUTIONS FROM
TEXTRON INC............. -- 49,010 -- -- -- 49,010
DIVIDENDS TO TEXTRON
INC. ................... -- (9,010) -- -- (42,100) (51,110)
---- -------- -------- -------- -------- ----------
BALANCE DECEMBER 29,
2001.................... $250 $573,676 $(25,000) $(18,793) $479,222 $1,009,355
==== ======== ======== ======== ======== ==========
</Table>
See notes to consolidated financial statements.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Textron Financial Corporation (Textron Financial or the Company) is a
diversified commercial finance company with core operations in four segments:
Aircraft Finance, Revolving Credit, Specialty Finance and Structured Capital.
The Aircraft Finance segment is focused on financing Cessna aircraft, Bell
helicopters and other general aviation aircraft. The Revolving Credit segment
specializes in dealer floorplan financing, asset-based lending and small
business financing. The Specialty Finance segment includes golf course and
equipment finance, financing for developers of vacation interval resorts and
residential and recreational land lots, franchise finance and media finance. The
Structured Capital segment includes leveraged lease transactions and investment
grade and near investment grade structured secured term and revolving credit
facilities. This segment also originates factoring arrangements and working
capital loans in the telecommunications, trucking and specialty financial
services industries. Textron Financial's other financial services and products
include transaction syndications, equipment appraisal and disposition, portfolio
servicing and insurance brokerage.
Textron Financial's financing activities are confined almost exclusively to
secured lending and leasing to commercial markets. Textron Financial's services
are offered primarily in North America. However, Textron Financial does finance
Textron products worldwide, principally Bell helicopters and Cessna aircraft in
South America.
Textron Financial is a subsidiary of Textron Inc. (Textron), a $12 billion
multi-industry company with businesses in Aircraft, Fastening Systems,
Industrial Products, Industrial Components and Finance. At year-end 2001 and
2000, 22% of Textron Financial's total managed finance receivables were related
to Textron or Textron's products. Textron Financial's year-end dates conform
with Textron's year-end, which falls on the nearest Saturday to December 31.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Textron Financial and its subsidiaries, all of which are wholly-owned. All
significant intercompany transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in those statements and
accompanying notes. Actual results may differ from such estimates.
Finance Charges and Discounts
Finance charges and discounts include interest on loans, capital lease
earnings, leveraged lease earnings and discounts on certain revolving credit and
factoring arrangements. Finance charges are recognized in finance charge
revenues using the interest method to produce a constant rate of return over the
terms of the finance assets. Accrual of interest income is suspended for
accounts that are contractually delinquent by more than three months, unless
collection is not doubtful. In addition, detailed reviews of loans may result in
earlier suspension if collection is doubtful. Cash payments on nonaccrual
accounts, including finance charges, generally are applied to reduce loan
principal. Accrual of interest is resumed when the loan becomes contractually
current, and suspended interest income is recognized at that time.
Finance Receivable Origination Fees and Costs
Fees received and direct loan origination costs are deferred and amortized
to finance charge revenues over the contractual lives of the respective
receivables using the interest method. Unamortized amounts are recognized in
revenues when receivables are sold or paid in full.
30
Other Income
Other income includes securitization and syndication gains on the sale of
loans and leases, late charges, prepayment fees, residual gains, servicing fees
and other miscellaneous fees, which are primarily recognized as income when
received. It also includes earnings on retained interests in securitizations
including interest on subordinated certificates and cash reserve accounts as
well as the accretable yield on interest-only securities.
Allowance for Losses on Receivables
Provisions for losses on finance receivables are charged to income in
amounts sufficient to maintain the allowance at a level considered adequate to
cover losses in the existing receivable portfolio. Management evaluates the
allowance by examining current delinquencies, the characteristics of the
existing accounts, historical loss experience, the value of the underlying
collateral and general economic conditions and trends.
Finance receivables are charged off when they are deemed uncollectible.
Finance receivables are written down to the fair value (less estimated costs to
sell) of the related collateral at the earlier of the date the collateral is
repossessed or when no payment has been received for six months, unless
management deems the receivable collectible.
Loan Impairment
Textron Financial periodically assesses finance receivables, excluding
homogeneous loan portfolios and finance leases, for impairment. The Company
considers a loan to be impaired if the fair value of the loan is less than its
carrying amount and establishes a reserve based on this difference. Fair value
is based on the present value of expected future cash flows discounted at the
loan's effective interest rate, the loan's observable market price or, if the
loan is collaterally dependent at the fair value of the collateral. This
evaluation is inherently subjective, as it requires estimates including the
amount and timing of future cash flows expected to be received on impaired loans
that may differ from actual results.
Equipment on Operating Leases
Income from operating leases is recognized in equal amounts over the lease
term. The cost of such assets is capitalized and depreciated to estimated
residual values using the straight-line method over the estimated useful life of
the asset or the lease term.
Intangible Assets
Textron Financial amortizes the excess of cost over the fair value of net
assets acquired (goodwill) on a straight-line basis over periods ranging from 10
to 25 years. Accumulated amortization of goodwill at December 29, 2001 and
December 30, 2000, was $27.8 million and $15.8 million, respectively. At
December 29, 2001, approximately $51.4 million of net goodwill was deductible
for federal income tax purposes over 15 years.
Certain other identified intangible assets are being amortized over periods
ranging from five to six years.
Textron Financial periodically evaluates the recoverability of intangible
assets whenever events or changes in circumstances, such as declines in
revenues, earnings or cash flows or material adverse changes in the business
climate indicate that the carrying amount of an asset may not be recoverable.
This evaluation is based on projected, undiscounted cash flows generated by the
underlying assets. As of December 29, 2001, there was no impairment.
Pension Benefits and Postretirement Benefits Other than Pensions
Textron Financial participates in Textron's defined contribution and
defined benefit pension plans. The cost of the defined contribution plan
amounted to approximately $1.9 million, $1.5 million and $0.9 million in 2001,
2000 and 1999, respectively. The cost of the defined benefit pension plan
amounted to approximately $3.4 million, $2.7 million and $2.6 million in 2001,
2000 and 1999, respectively. Defined benefits under
31
salaried plans are based on salary and years of service. Textron's funding
policy is consistent with federal law and regulations. Pension plan assets
consist principally of corporate and government bonds and common stocks. Accrued
pension expense is included in Accrued interest and other liabilities on Textron
Financial's Consolidated Balance Sheets.
Income Taxes
Textron Financial's revenues and expenses are included in Textron's
consolidated tax return. Current tax expense is based on allocated federal tax
charges and benefits on the basis of statutory U.S. tax rates applied to the
Company's taxable income or loss included in Textron's consolidated returns.
Deferred income taxes are recognized for temporary differences between the
financial reporting basis and income tax basis of assets and liabilities, based
on enacted tax rates expected to be in effect when such amounts are expected to
be realized or settled.
Retained Interests in Securitizations
Textron Financial sells or securitizes loans and leases and retains
servicing responsibilities and subordinated interests, including interest-only
securities, subordinated certificates and cash reserves all of which are
retained interests in the securitized receivables. The Company's retained
interests are subordinate to other investor's interests in the securitizations.
Gain or loss on the sale of the loans or leases depends in part on the previous
carrying amount of the financial assets involved in the transfer, allocated
between the assets sold and the retained interests based on their relative fair
values at the date of transfer. The Company estimates fair values based on the
present value of future cash flows expected under management's best estimates of
key assumptions - credit losses, prepayment speeds, forward interest rate yield
curves and discount rates commensurate with the risks involved.
Textron Financial reviews the fair value of the retained interests
quarterly using updated assumptions and compares such amounts with the carrying
value of the retained interests. When the carrying value exceeds the fair value
of the retained interests, the Company determines whether the decline in fair
value is other than temporary. When the Company determines the decline in fair
value is other than temporary, it writes down the retained interest to fair
value with a corresponding charge to income. When a change in fair value of the
Company's retained interests is deemed temporary, the Company records a
corresponding credit or charge to Other comprehensive income for any unrealized
gains and losses.
Derivative Financial Instruments
Textron Financial has entered into various interest rate and foreign
exchange agreements to mitigate its exposure to changes in interest and foreign
exchange rates. Effective December 31, 2000, the Company adopted Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133), as amended. In accordance with SFAS No.
133, the Company records all derivative financial instruments on its balance
sheet at fair value and recognizes changes in fair values in current earnings
unless the derivatives qualify as hedges of future cash flows. For derivatives
qualifying as hedges of future cash flows, the Company records the effective
portion of the change in fair value as a component of Other comprehensive income
in the periods the hedged transaction affects earnings. In accordance with SFAS
No. 133, the Company recorded a cumulative transition adjustment to decrease
Other comprehensive income by approximately $11.6 million, net of taxes, to
recognize the fair value of cash flow hedges as of the date of adoption.
Textron Financial recognizes the net interest differential on interest rate
exchange agreements, including premiums paid or received, as adjustments to
finance income or interest expense to correspond with the hedged positions. In
the event of an early termination of a derivative financial instrument, the
Company defers the gain or loss in Other comprehensive income until it
recognizes the hedged transaction in earnings.
While these exchange agreements expose Textron Financial to credit losses
in the event of nonperformance by the counterparties to the agreements, the
Company does not expect any such nonperformance. The
32
Company minimizes the risk of nonperformance by entering into contracts with
financially sound counterparties having long-term bond ratings of no less than
middle A, by continuously monitoring such credit ratings and by limiting its
exposure with any one financial institution. Textron Financial had minimal
exposure to loss from nonperformance by the counterparties to these agreements
at the end of 2001.
Fair Value of Financial Instruments
Fair values of financial instruments are based upon estimates at a specific
point in time using available market information and appropriate valuation
methodologies. These estimates are subjective in nature and involve
uncertainties and significant judgment in the interpretation of current market
data. Therefore, the fair values presented are not necessarily indicative of
amounts Textron Financial could realize or settle currently. Textron Financial
does not necessarily intend to dispose of or liquidate such instruments prior to
maturity.
Cash and Equivalents
Cash and equivalents consist of cash in banks and overnight
interest-bearing deposits in banks.
Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year presentation.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations," and No. 142, "Goodwill and Other Intangible Assets," effective
for fiscal years beginning after December 15, 2001. Under the new rules,
goodwill, along with intangible assets deemed to have indefinite lives, will no
longer be amortized but will be subject to annual impairment tests in accordance
with the Statements. Also, business combinations initiated after June 30, 2001,
must be accounted for using the purchase method accounting.
Textron Financial will apply the new rules on accounting for goodwill and
other intangible assets beginning in the first quarter of 2002. Application of
the nonamortization provisions of the Statement would have resulted in an
increase in net income of $11.2 million. During 2002, Textron Financial will
perform the first of the required impairment tests of goodwill and indefinite
lived intangible assets as of December 30, 2001, and has not yet determined what
the effect of these tests will be on the operations and financial position of
the Company.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment and Disposal of Long-Lived Assets." SFAS No. 144 requires that one
accounting model be used for long-lived assets to be disposed of by sale.
Discontinued operations will be measured similar to other long-lived assets
classified as held for sale at the lower of its carrying amount or fair value
less cost to sell. Future operating losses will no longer be recognized as they
occur. SFAS No. 144 also broadens the presentation of discontinued operations to
include a component of an entity when operations and cash flows can be clearly
distinguished, and is effective for financial statements issued for fiscal years
beginning after December 15, 2001. At this time, the adoption of this Statement
is not expected to have a material effect on the Company's results of operations
or financial position.
33
NOTE 2 OTHER INCOME
<Table>
<Caption>
2001 2000 1999
-------- ------- -------
(In thousands)
Securitization gains........................................ $ 42,799 $22,053 --
Prepayment gains............................................ 25,665 9,324 $ 8,754
Syndication gains........................................... 25,500 14,533 13,552
Servicing fees.............................................. 16,798 5,080 3,308
Investment income........................................... 16,119 5,650 9,769
Late charges................................................ 10,069 7,681 7,442
Other....................................................... 26,505 19,852 13,484
-------- ------- -------
Total other income.......................................... $163,455 $84,173 $56,309
======== ======= =======
</Table>
The Other component of Other income includes custodial fees, commitment
fees, residual gains, insurance fees and other miscellaneous fees which are
primarily recognized as income when received.
NOTE 3 SPECIAL CHARGES
The Company records restructuring liabilities at the time management
approves and commits to a restructuring plan that identifies all significant
actions to be taken and the expected completion date of the plan. The
restructuring liability includes those restructuring costs that (1) can be
reasonably estimated, (2) are not associated with and do not benefit activities
that will be continued and (3) are not associated with or are not incurred to
generate revenues after the commitment date. Restructuring costs are incurred as
a direct result of the plan and (1) are incremental to other costs incurred by
Textron Financial in the conduct of its activities prior to the commitment date,
or (2) represent contractual obligations that existed prior to the commitment
date and will either continue after the exit plan is completed with no economic
benefit to the enterprise or reflect a penalty to cancel a contractual
obligation.
To enhance its competitiveness and profitability, the Company committed to
a plan to restructure its vendor finance and existing small business finance
operations, in the second quarter and its aircraft finance and machine tool
finance operations in the third quarter. As a result, the Company recognized
charges of $2.7 million for the year ended December 29, 2001.
As a result of the restructuring program, the Company terminated 155
employees and closed two facilities. The restructuring charges related to
employee terminations include the cost of severance related benefits based on
established policies and practices. As of December 29, 2001, the Company has
paid severance related benefits and other expenses of $1.8 million, which have
been charged against the restructuring reserve, leaving a balance in the reserve
of $0.9 million. The Company expects to pay the remaining restructuring costs by
August 2002.
The identified restructuring measures and associated estimated costs are
based on the Company's best judgment under the prevailing circumstances. Based
on such circumstances, the Company believes the restructuring reserve balance is
adequate to carry out its committed restructuring plan as of December 29, 2001.
NOTE 4 RELATIONSHIP WITH TEXTRON INC.
Textron Financial is a wholly-owned subsidiary of Textron and derives a
portion of its business from financing the sale and lease of products
manufactured and sold by Textron. Textron Financial recognized finance charge
revenues from Textron and affiliates (net of payments or reimbursements for
interest charged at more or less than market rates on Textron manufactured
products) of $4.0 million in 2001, $11.6 million in 2000 and $7.2 million in
1999, and operating lease revenues of $10.9 million in 2001, $10.9 million in
2000 and $9.5 million in 1999. In 2001, 2000 and 1999, Textron Financial paid
Textron $1.3 billion, $1.4 billion and $1.3 billion, respectively, for the
purchase of receivables and operating lease equipment.
34
Textron Financial and Textron are parties to several agreements,
collectively referred to as operating agreements, which govern many areas of the
Textron Financial-Textron relationship. Under operating agreements with Textron,
Textron Financial has recourse to Textron with respect to certain finance
receivables and operating leases. Finance receivables of $560.9 million at
December 29, 2001, and $833.7 million at December 30, 2000, and operating leases
of $90.6 million at December 29, 2001, and $69.0 million at December 30, 2000,
were subject to recourse to Textron or due from Textron. In addition, Textron
Financial had recourse to Textron on subordinated certificates of $55.8 million
and $37.8 million at year-end 2001 and 2000, respectively, and on cash reserve
accounts of $13.9 million and $14.4 million at year-end 2001 and 2000,
respectively. Both the subordinated certificates and the cash reserve accounts
are retained interests related to receivable securitizations.
During 2001, Textron Financial entered into an $87 million lease agreement
with Textron Automotive Trim. In connection with Textron's disposition of its
Automotive Trim business, this lease obligation was assumed by the acquirer of
the Automotive Trim business. Additionally, as part of the sale Textron also
made an investment in the acquirer, consisting of non-marketable preferred
shares of the acquirer valued at $147 million and 18 million shares of common
stock of the acquirer valued at $90 million.
Under the operating agreements between Textron and Textron Financial,
Textron has made available to Textron Financial a $100 million line of credit
for junior subordinated borrowings at the prime interest rate (4.75% at December
29, 2001). Textron Financial had no borrowings under this line at December 29,
2001. However, $2.3 million of the line has been reserved for credit support of
a securitization conduit. In addition, Textron has agreed to lend Textron
Financial, interest-free, an amount not to exceed the deferred income tax
liability of Textron attributable to the manufacturing profit deferred for tax
purposes on products manufactured by Textron and financed by Textron Financial.
The Company had borrowings from Textron of $20.9 million at December 29, 2001
($21.6 million at December 30, 2000) under this arrangement. These borrowings
are reflected in Amounts due to Textron Inc. on Textron Financial's Consolidated
Balance Sheets. In addition, Textron Financial had $510 million outstanding
under a short-term revolving note agreement that is fully discussed in Note 9 to
the consolidated financial statements.
Textron has also agreed to cause Textron Financial's pretax income
available for fixed charges to be not less than 125% of its fixed charges and
its consolidated Shareholder's equity to be not less than $200 million. No
related payments were required for 2001, 2000 or 1999.
The Company had income tax receivables of $3.8 million and $8.7 million at
December 29, 2001 and December 30, 2000, respectively, and these accounts are
settled with Textron as Textron manages its consolidated federal tax position.
NOTE 5 FINANCE RECEIVABLES
Contractual Maturities
The contractual maturities of finance receivables outstanding at December
29, 2001, were as follows:
<Table>
<Caption>
2002 2003 2004 2005 2006 THEREAFTER TOTAL
---------- -------- -------- -------- -------- ---------- ----------
(In thousands)
Installment
contracts........... $ 359,148 $210,282 $181,317 $174,143 $136,822 $ 985,376 $2,047,088
Revolving loans....... 691,054 249,226 89,721 266,163 203,775 78,983 1,578,922
Golf course and resort
mortgages........... 102,465 94,705 100,546 120,697 137,350 255,771 811,534
Floorplan
receivables......... 326,731 92,062 2,647 10,676 20,671 21,604 474,391
Leveraged leases...... (16,888) (13,993) 27,697 17,943 9,588 380,076 404,423
Finance leases........ 41,560 37,364 44,249 126,216 14,049 55,421 318,859
Commercial real estate
mortgages........... 417 -- -- -- -- -- 417
---------- -------- -------- -------- -------- ---------- ----------
Total finance
receivables......... $1,504,487 $669,646 $446,177 $715,838 $522,255 $1,777,231 $5,635,634
========== ======== ======== ======== ======== ========== ==========
</Table>
35
Finance receivables often are repaid or refinanced prior to contractual
maturity. Accordingly, the above tabulation should not be regarded as a forecast
of future cash collections. The ratio of cash collections (net of finance
charges) to average net receivables, excluding floorplan receivables and
revolving loans, was approximately 65% in 2001 and 59% in 2000. During 2001 and
2000, cash collections of finance receivables (excluding proceeds from
receivable sales or securitizations) were $5.8 billion and $5.2 billion,
respectively.
Installment contracts and finance leases have initial terms generally
ranging from one to fifteen years. Installment contracts and finance leases are
secured by the financed equipment and, in some instances, by the personal
guarantee of the principals or recourse arrangements with the originating
vendor. Finance leases include residual values expected to be realized at
contractual maturity.
Revolving loans generally have terms of one to three years, and at times
convert to term loans that contractually amortize over an average term of seven
years. Revolving loans consist of loans secured by trade receivables, inventory,
plant and equipment, pools of vacation interval resort notes receivable, pools
of residential and recreational land lots and the underlying real property.
Floorplan receivables generally mature within one year. Floorplan receivables
are secured by the inventory of the financed distributor or dealer and, in some
programs, by recourse arrangements with the originating manufacturer. Revolving
loans and floorplan receivables are cyclical and result in cash turnover that is
several times larger than contractual maturities. In 2001, such cash turnover
was 3.9 times contractual maturities.
Golf course mortgages have initial terms generally ranging from three to
seven years with amortization periods from 15 to 25 years. Resort mortgages
generally represent construction and inventory loans with terms up to two years.
Golf course and resort mortgages are secured by real property and are generally
limited to 75% or less of the property's appraised market value at loan
origination. Golf course mortgages, totaling $553.8 million, consist of loans
with an average balance of $5.1 million and an average remaining contractual
maturity of three years. Resort mortgages, totaling $257.7 million, consist of
loans with an average balance of $3.5 million and an average remaining
contractual maturity of two years.
Leveraged leases are secured by the ownership of the leased equipment and
real property. Leveraged leases reflect contractual maturities net of
contractual nonrecourse debt payments and include residual values expected to be
realized at contractual maturity. Leveraged leases have initial terms up to
approximately 30 years.
Textron Financial's finance receivables are diversified across geographic
region, borrower industry and type of collateral. Textron Financial's owned and
securitized receivable geographic concentrations at December 29, 2001, were as
follows: Southeast 26%; Far West 15%; Southwest 12%; Mideast 10%; Great Lakes
10%; New England 5%; Rocky Mountains 5%; other domestic 5%; South America 4%;
and other international 8%. Textron Financial's most significant collateral
concentration was general aviation aircraft, which accounted for 23% of owned
and securitized receivables (17% of owned receivables) at December 29, 2001. The
Company has industry concentrations in the golf and vacation interval
industries, which accounted for 17% and 11%, respectively, of owned and
securitized receivables.
Leveraged Leases
<Table>
<Caption>
2001 2000
---------- ----------
(In thousands)
Rental receivable........................................... $1,180,292 $1,044,642
Nonrecourse debt............................................ (905,960) (830,697)
Estimated residual values of leased assets.................. 401,745 425,391
Less unearned income........................................ (271,654) (278,354)
---------- ----------
Investment in leveraged leases.............................. 404,423 360,982
Deferred income taxes....................................... (258,385) (264,898)
Fees payable................................................ -- (300)
---------- ----------
Net investment in leveraged leases.......................... $ 146,038 $ 95,784
========== ==========
</Table>
36
Approximately 47% of Textron Financial's investment in leveraged leases is
collateralized by real estate.
The components of income from leveraged leases were as follows:
<Table>
<Caption>
2001 2000 1999
------- ------- -------
(In thousands)
Income recognized........................................... $25,586 $21,973 $23,139
Income tax expense.......................................... (9,237) (8,240) (8,844)
------- ------- -------
Income from leveraged leases................................ $16,349 $13,733 $14,295
======= ======= =======
</Table>
Finance Leases
<Table>
<Caption>
2001 2000
-------- --------
(In thousands)
Total minimum lease payments receivable..................... $215,526 $311,774
Estimated residual values of leased equipment............... 187,626 146,357
-------- --------
403,152 458,131
Unearned income............................................. (84,293) (97,492)
-------- --------
Net investment in finance leases............................ $318,859 $360,639
======== ========
</Table>
Minimum lease payments due under finance leases for each of the next five
years and the aggregate amounts due thereafter are as follows: $56.1 million in
2002, $50.2 million in 2003, $33.4 million in 2004, $41.3 million in 2005, $12.4
million in 2006 and $22.1 million thereafter.
Loan Impairment
The Company had $113.8 million of nonaccrual finance receivables at
December 29, 2001, compared to $101.9 million at December 30, 2000. Excluding
homogeneous loan portfolios and finance leases, the Company had $53.9 million of
nonaccrual finance receivables at December 29, 2001, compared to $76.4 million
at December 30, 2000, which were considered impaired. The allowance for losses
on receivables related to impaired loans was $10.9 million at December 29, 2001,
and $34.1 million at December 30, 2000. The average recorded investment in
impaired loans during 2001 was $51.1 million, compared to $75.7 million in 2000.
Nonaccrual loans resulted in Textron Financial's revenues being reduced by
approximately $10.4 million, $8.6 million and $4.7 million for 2001, 2000 and
1999, respectively. No interest income was recognized using the cash basis
method.
Captive finance receivables with recourse that were 90 days or more
delinquent amounted to 16.0%, 12.6% and 8.9% of captive finance receivables with
recourse for the years ended 2001, 2000 and 1999, respectively. Revenues
recognized on these delinquent accounts were approximately $9.5 million, $10.1
million and $7.0 million for the years ended 2001, 2000 and 1999, respectively.
Allowance for Losses on Receivables
<Table>
<Caption>
2001 2000 1999
-------- -------- --------
(In thousands)
Balance at beginning of year............................... $115,953 $112,769 $ 83,887
Provision for losses....................................... 81,679 36,704 32,067
Receivable charge-offs..................................... (82,272) (44,699) (28,293)
Recoveries................................................. 7,823 6,871 4,676
Acquisitions and other..................................... 20,573 4,308 20,432
-------- -------- --------
Balance at end of year..................................... $143,756 $115,953 $112,769
======== ======== ========
</Table>
The provision for losses in 1999 included $2.2 million for the valuation
allowance on other real estate owned.
37
Managed Finance Receivables
Textron Financial manages finance receivables for a variety of investors,
participants and third-party portfolio owners.
<Table>
<Caption>
2001 2000
---------- ----------
(In thousands)
Owned receivables........................................... $5,635,634 $5,589,412
Securitized receivables..................................... 2,332,025 1,324,089
---------- ----------
7,967,659 6,913,501
Nonrecourse participations.................................. 591,853 573,157
Third-party portfolio servicing............................. 740,246 445,207
SBA sales agreements........................................ 49,338 33,222
---------- ----------
Total managed finance receivables........................... $9,349,096 $7,965,087
========== ==========
</Table>
Nonrecourse participations consist of undivided interests in loans
originated by Textron Financial, primarily in vacation interval resorts and golf
finance, which are sold to independent investors.
The third-party portfolio servicing amounts largely represent finance
receivable portfolios of resort developers and third-party securitizations as
well as banks and leasing companies.
Owned receivables include approximately $63 million of noncash finance
receivable additions, which were unfunded at December 29, 2001, primarily
holdback arrangements. The corresponding liability is included in Accrued
interest and other liabilities on the Consolidated Balance Sheets.
NOTE 6 RECEIVABLE SECURITIZATIONS
During 2001, the Company securitized general aviation loans, franchise
loans, finance receivables for the lease or purchase of E-Z-GO golf cars and
Textron Turf Care equipment (equipment loans and leases), floorplan loans,
receivable finance loans (vacation interval loans) and loans for residential and
recreational land lots (land loan receivables) and recognized pretax gains of
$12.3 million, $3.4 million, $2.4 million, $16.5 million, $1.9 million and $6.3
million, respectively. During 2000, the Company securitized general aviation
aircraft loans, franchise loans, equipment loans and leases, and land loan
receivables and recognized pretax gains of $11.8 million, $3.3 million, $0.4
million and $6.6 million, respectively. The Company receives annual servicing
fees approximating 0.75% (for general aviation aircraft loans and equipment
loans and leases), 0.30% (for franchise loans), 1.50% (for floorplan loans),
1.00% (for vacation interval loans) and 0.50% (for land loans receivables) of
the outstanding balance and rights to future cash flows arising after the
investors in the securitization trusts have received the return for which they
have contracted. The investors and the securitizations trusts have no recourse
to the Company's other assets and liabilities for failure of debtors to pay when
due.
Textron Financial has entered into certain interest rate exchange
agreements to mitigate its exposure to decreases in interest rates on its
interest-only securities. For more information regarding Textron Financial's
interest rate exchange agreements, see Note 10 to the consolidated financial
statements.
Additionally, Textron Financial has recourse to Textron on certain retained
interests as described in Note 4 to the consolidated financial statements.
38
Key economic assumptions used in measuring the retained interests at the
date of securitization resulting from securitizations completed during 2001 were
as follows:
<Table>
<Caption>
VACATION
GENERAL AVIATION FRANCHISE EQUIPMENT FLOORPLAN INTERVAL LAND LOAN
AIRCRAFT LOANS LOANS LOANS AND LEASES LOANS LOANS RECEIVABLES
---------------- --------- ---------------- --------- -------- -----------
Prepayment speed (annual rate)..... 20.0% 8.0% 7.5% -- 15.0% 20.0%
Weighted average life (in years)... 4.0 8.0 2.1 0.3 7.1 8.9
Expected credit losses (annual
rate)............................ 0.2% 0.3% 0.2% 1.0% 0.5% 1.5%
Residual cash flows discount
rate............................. 7.6% 9.0% 7.1% 9.4% 9.3% 11.0%
</Table>
At December 29, 2001, key economic assumptions and the sensitivity of the
current fair value of residual cash flows to immediate 10% and 20% adverse
changes in those assumptions are as follows:
<Table>
<Caption>
VACATION
GENERAL AVIATION FRANCHISE EQUIPMENT FLOORPLAN INTERVAL LAND LOAN
AIRCRAFT LOANS LOANS LOANS AND LEASES LOANS LOANS RECEIVABLES
---------------- --------- ---------------- --------- -------- -----------
(Dollars in millions)
Carrying amount of retained
interests in
securitizations -- net........... $66.5 $36.5 $41.2 $68.1 $ 2.1 $20.4
Weighted average life (in years)... 3.6 8.0 1.8 0.3 7.1 8.9
PREPAYMENT SPEED (ANNUAL RATE)..... 21.0% 8.0% 6.6% -- 15.0% 20.0%
10% adverse change................. $(1.7) $(1.2) $(0.1) -- $(0.2) $(1.0)
20% adverse change................. (3.0) (2.2) (0.2) -- (0.3) (1.9)
EXPECTED CREDIT LOSSES (ANNUAL
RATE)............................ 0.2% 0.3% 0.2% 1.0% 0.5% 1.5%
10% adverse change................. $(0.1) $(0.1) -- -- -- $(0.2)
20% adverse change................. (0.2) (0.2) -- -- -- (0.4)
RESIDUAL CASH FLOWS DISCOUNT
RATE............................. 8.2% 9.0% 7.0% 9.0% 9.3% 11.0%
10% adverse change................. $(1.1) $(1.5) $(0.5) $(0.3) $(0.1) $(0.9)
20% adverse change................. (2.3) (2.9) (0.9) (0.5) (0.1) (1.7)
</Table>
These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in fair value based on a 10% variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption, in reality, changes in one factor may result in another that may
magnify or counteract the sensitivities losses, such as increases in market
interest rates may result in lower prepayments and increased credit losses.
Static pool losses are calculated by summing the actual and projected
future credit losses and dividing them by the original balance of each pool of
assets. At December 29, 2001, total expected losses for securitizations
occurring in 2001 were 0.47% for general aviation aircraft loans, 0.20% for
equipment loans and leases, 1.30% for franchise loans, 0.25% for floorplan
loans, 2.18% for vacation interval loans and 4.17% for land loan receivables.
Total expected losses for securitizations occurring in 2000 were 0.36% for
general aviation aircraft loans, 0.13% for equipment loans and leases, 1.41% for
franchise loans and 2.11% for land loan receivables.
At December 30, 2000, the total expected losses for securitizations
occurring in 2000 were 0.52% for general aviation aircraft loans, 0.25% for
equipment loans and leases, 2.08% for franchise loans and 4.30% for land loan
receivables. There were no loans securitized in 1999.
39
The table below summarizes certain cash flows received from and (paid to)
securitization trusts during the years ended December 29, 2001 and December 30,
2000.
<Table>
<Caption>
2001 2000
-------- --------
(In millions)
Proceeds from 2001 securitizations.......................... $1,296.8 $1,116.9
Servicing fees received..................................... 14.9 3.3
Cash flows received on retained interests................... 38.2 11.5
</Table>
Historical loss and delinquency amounts for loans held and securitized for
the year ended December 29, 2001, were as follows:
<Table>
<Caption>
TOTAL AGGREGATE
PRINCIPAL CONTRACT
AMOUNT VALUE 60 NET
OF LOANS DAYS OR MORE AVERAGE CREDIT
TYPE OF FINANCE RECEIVABLE AND LEASES PAST DUE BALANCES LOSSES
- -------------------------- --------------- ------------ -------- ------
YEAR-ENDED
AT DECEMBER 29, 2001 DECEMBER 29, 2001
------------------------------- ------------------
(In millions)
General aviation aircraft loans............... $1,852.0 $ 32.3 $1,780.9 $ 8.5
Franchise loans............................... 545.2 4.7 482.0 3.7
Equipment loans and leases.................... 586.7 59.0 548.2 1.4
Floorplan loans............................... 1,724.7 5.4 1,383.4 7.3
Vacation interval loans....................... 887.4 2.6 776.5 0.3
Land loan receivables......................... 233.4 9.8 216.3 0.8
-------- ------ -------- -----
Total loans held and securitized.............. $5,829.4 $113.8 $5,187.3 $22.0
-------- ------ ======== =====
CONSISTING OF:
Loans held in portfolio....................... $3,497.4 $ 44.9
Loans securitized............................. 2,332.0 68.9
-------- ------
Total loans held and securitized.............. $5,829.4 $113.8
======== ======
</Table>
NOTE 7 EQUIPMENT ON OPERATING LEASES
<Table>
<Caption>
2001 2000
-------- --------
(In thousands)
Equipment on operating leases, at cost:
Aircraft.................................................. $201,250 $150,598
Golf cars................................................. 30,864 5,489
Accumulated depreciation:
Aircraft and golf cars.................................... (31,054) (20,731)
-------- --------
Equipment on operating leases -- net........................ $201,060 $135,356
======== ========
</Table>
Initial lease terms of equipment on operating leases range from one year to
twelve years. Future minimum rentals at December 29, 2001, are $24.2 million in
2002, $14.5 million in 2003, $12.9 million in 2004, $11.1 million in 2005, $8.6
million in 2006 and $14.7 million thereafter.
40
NOTE 8 OTHER ASSETS
<Table>
<Caption>
2001 2000
-------- --------
(In thousands)
Retained interests in securitizations....................... $257,538 $129,608
Investment in equipment residuals........................... 112,804 51,204
Short-term investments...................................... 63,819 --
Fixed assets -- net......................................... 44,680 36,382
Other long-term investments................................. 24,723 19,212
Repossessed assets and properties........................... 23,235 9,281
Acquisition, development and construction (ADC)
arrangements.............................................. -- 32,619
Other....................................................... 22,168 21,569
-------- --------
Total other assets.......................................... $548,967 $299,875
======== ========
</Table>
The Investment in equipment residuals represents the remaining equipment
residual values associated with the aircraft and Textron golf and turf equipment
lease payments that were securitized in 2001 and 2000. The cost of fixed assets
is being depreciated using the straight-line method based on the estimated
useful lives of the assets.
NOTE 9 DEBT AND CREDIT FACILITIES
<Table>
<Caption>
2001 2000
---------- ----------
(In thousands)
Short-term debt:
Commercial paper.......................................... $ 623,252 $ 955,812
Other short-term debt..................................... 574,455 9,990
---------- ----------
Total short-term debt............................. 1,197,707 965,802
Long-term debt:
5.66% -- 5.95% notes; due 2002 to 2004.................... 399,503 218,000
6.13% -- 6.73% notes; due 2003............................ 31,637 133,264
7.13% -- 7.67% notes; due 2002 to 2004.................... 1,081,223 1,080,618
Variable rate notes due 2002 to 2004...................... 1,988,350 2,269,185
---------- ----------
Total long-term debt.............................. 3,500,713 3,701,067
---------- ----------
Total debt........................................ $4,698,420 $4,666,869
========== ==========
</Table>
At December 29, 2001, $510 million of Textron Financial's Other short-term
debt outstanding represented borrowings under a short-term revolving note
agreement with Textron. This agreement with Textron was the direct result of
Textron's sale of its Automotive Trim division at year-end and the availability
of the resulting cash proceeds. In lieu of investing in other investment grade,
short-term debt securities, Textron and Textron Financial concluded it was most
effective for Textron to invest in Textron Financial's short-term obligations.
This arrangement was structured through the revolving note agreement instead of
buying Textron Financial's commercial paper in the marketplace. At January 24,
2002, Textron Financial had paid off its obligation and terminated this
agreement.
Textron Financial has lines of credit with a bank group aggregating $1.5
billion at December 29, 2001, of which $500 million will expire in 2002 and $1.0
billion will expire in 2006. Textron Financial's lines of credit, including the
$100 million line of credit with Textron, not used or reserved as support for
commercial paper or a securitization conduit at December 29, 2001, were $975
million. The Company also maintains a C$50 million committed Canadian facility
under which it can borrow an additional C$80 million on an uncommitted basis. At
December 29, 2001, the Company has fully used the committed portion of the
facility in addition to borrowing C$63 million under the uncommitted portion of
the facility. Textron Financial also
41
has a $25 million UK facility, of which $15 million remains unused at year-end
2001. Both the Canadian and UK facilities expire in 2002. Textron Financial
generally pays fees in support of these lines.
The weighted average interest rates on short-term borrowings, before
consideration of the effect of interest rate exchange agreements at year-end
were as follows:
<Table>
<Caption>
2001 2000 1999
---- ---- ----
Commercial paper............................................ 2.37% 6.66% 6.59%
Other short-term debt....................................... 2.41% 7.13% 5.90%
</Table>
The corresponding weighted average interest rates on these borrowings
during the last three years were 4.12% in 2001, 6.44% in 2000 and 5.40% in 1999.
Weighted average interest rates have been determined by relating interest costs
for each year to the daily average dollar amounts outstanding.
Interest on Textron Financial's variable rate notes is predominately tied
to the three-month LIBOR for U.S. dollar deposits. The weighted average interest
rate on these notes was 2.41% at December 29, 2001, 6.96% at December 30, 2000,
and 6.39% at January 1, 2000. The corresponding weighted average interest rates
on these notes during the last three years were 4.89% in 2001, 6.93% in 2000 and
5.67% in 1999.
The amount of net assets available for dividends and other payments to
Textron is restricted by the terms of the Company's lending agreements. At
December 29, 2001, $452.0 million of net assets were available to be transferred
to Textron under the most restrictive covenant. The lending agreements contain
various restrictive provisions regarding additional debt (not to exceed 800% of
consolidated net worth and qualifying subordinated obligations), minimum net
worth ($200 million), the creation of liens and the maintenance of a fixed
charges coverage ratio (not less than 125%).
Through its subsidiary, Textron Financial Canada Funding Corp. (Textron
Canada Funding), the Company may periodically issue debt securities. Textron
Financial owns 100% percent of the common stock of Textron Canada Funding.
Textron Canada Funding is a financing subsidiary of Textron Financial with no
operations, revenues or cash flows other than those related to the issuance,
administration and repayment of debt securities that are or will be fully and
unconditionally guaranteed by Textron Financial.
Required principal payments during the next five years on long-term debt
outstanding at December 29, 2001, are $1,580.0 million in 2002, $983.0 million
in 2003 and $937.7 million in 2004.
Cash payments made by Textron Financial for interest were $281.5 million in
2001, $324.7 million in 2000 and $181.9 million in 1999.
NOTE 10 DERIVATIVE FINANCIAL INSTRUMENTS
Textron Financial entered into interest rate exchange agreements to
mitigate its exposure to interest rate changes by converting certain of its
fixed rate receivables and debt issues to floating rates. The agreements require
the Company to make periodic fixed rate payments in exchange for floating rate
receipts based on specified notional amounts. Textron Financial also entered
into a foreign currency exchange agreement to convert a $32.5 million variable
rate note to a C$50 million variable rate note. The agreement requires the
Company to make Canadian dollar payments based on BA-CDOR in exchange for
receipts of U.S. dollars based on LIBOR at specified notional amounts. The
Company has designated these agreements fair value hedges. The Company does not
hold or issue derivative financial instruments for trading or speculative
purposes.
Textron Financial has also entered into interest rate exchange, cap and
floor agreements to mitigate its exposure on interest-only securities resulting
from securitizations. The exchange agreements require the Company to make
periodic variable payments in exchange for periodic fixed rate receipts and vice
versa based on specified notional amounts. The interest rate cap and floor
agreements require the Company to make periodic variable rate payments based on
specified notional amounts if interest rates exceed or fall below specified
rates. The Company has designated these agreements as cash flow hedges.
42
Textron Financial has not incurred or recognized any gains or losses in
earnings as the result of the ineffectiveness or the exclusion from its
assessment of hedge effectiveness of its fair value or cash flow hedges.
Assuming no changes in interest rates, the Company expects $7.3 million of
net deferred losses to be reclassified to earnings over the next year to offset
interest payments made or received. In addition, the Company expects that
approximately $2.3 million, net of income taxes, to be reclassified to earnings
as a result of the amortization of deferred losses related to discontinued
hedges.
The derivative financial instruments are summarized as follows:
<Table>
<Caption>
2001 2000
---------- ----------
(Dollars in thousands)
FAIR VALUE HEDGES
INTEREST RATE EXCHANGE AGREEMENTS DESIGNATED AGAINST FIXED
RATE RECEIVABLES:
Notional principal.......................................... $96,909 $100,000
Weighted average remaining term............................. 12.0 YEARS 12.6 years
Fixed weighted average interest rate........................ 8.14% 8.14%
Variable weighted average interest rate..................... 3.10% 7.91%
INTEREST RATE EXCHANGE AGREEMENTS DESIGNATED AGAINST FIXED
RATE DEBT:
Notional principal.......................................... $370,000 --
Weighted average remaining term............................. 0.6 YEARS --
Variable weighted average interest rate..................... 1.88% --
Fixed weighted average interest rate........................ 4.08% --
FOREIGN CURRENCY AND INTEREST RATE BASIS EXCHANGE AGREEMENT
DESIGNATED AGAINST FOREIGN DEBT:
Notional principal.......................................... $32,500 $32,500
Weighted average remaining term............................. 1.9 YEARS 2.9 years
Variable weighted average interest rate -- BA-CDOR.......... 3.12% 6.85%
Variable weighted average interest rate -- LIBOR............ 2.75% 7.41%
CASH FLOW HEDGES
INTEREST RATE EXCHANGE AGREEMENTS DESIGNATED AGAINST
VARIABLE RATE DEBT:
Notional principal.......................................... -- $150,000
Weighted average remaining term............................. -- 1.2 years
Fixed weighted average interest rate........................ -- 6.52%
Variable weighted average interest rate..................... -- 6.77%
FORWARD STARTING INTEREST RATE EXCHANGE AGREEMENTS
DESIGNATED AGAINST VARIABLE RATE DEBT:
Notional principal.......................................... -- $228,800
Weighted average remaining term............................. -- 7.0 years
Fixed weighted average interest rate........................ -- 7.31%
Variable weighted average interest rate..................... -- LIBOR
INTEREST RATE BASIS EXCHANGE AGREEMENTS DESIGNATED AGAINST
VARIABLE RATE DEBT:
Notional principal.......................................... -- $715,000
Weighted average remaining term............................. -- 0.1 years
Float based on prime rate................................... -- 6.77%
Float based on LIBOR........................................ -- 6.77%
LIBOR BASED INTEREST RATE EXCHANGE AGREEMENTS DESIGNATED
AGAINST VARIABLE RATE INTEREST-ONLY SECURITIES:
Notional principal.......................................... $370,970 $145,100
Weighted average remaining term............................. 6.5 YEARS 7.0 years
Variable weighted average interest rate..................... 2.57% 7.39%
Fixed weighted average interest rate........................ 5.71% 6.79%
</Table>
43
<Table>
<Caption>
2001 2000
---------- ----------
(Dollars in thousands)
PRIME RATE BASED INTEREST RATE EXCHANGE AGREEMENTS
DESIGNATED AGAINST VARIABLE RATE INTEREST-ONLY SECURITIES:
Notional principal.......................................... $111,735 $172,500
Weighted average remaining term............................. 16.7 YEARS 17.0 years
Variable weighted average interest rate..................... 5.16% 9.65%
Fixed weighted average interest rate........................ 9.00% 8.93%
ONE-MONTH LIBOR BASED INTEREST RATE CAP AGREEMENTS
DESIGNATED AGAINST VARIABLE RATE INTEREST-ONLY SECURITIES:
Notional principal tied to the one-month LIBOR.............. $337,274 --
Weighted average cap rate................................... 6.35% --
PRIME RATE BASED INTEREST RATE FLOOR AGREEMENTS DESIGNATED
AGAINST VARIABLE RATE INTEREST-ONLY SECURITIES:
Notional principal tied to the prime rate................... $148,420 $162,995
Weighted average floor rate................................. 8.73% 8.72%
SIX-MONTH LIBOR BASED INTEREST RATE FLOOR AGREEMENTS
DESIGNATED AGAINST VARIABLE RATE INTEREST-ONLY SECURITIES:
Notional principal tied to the six-month LIBOR.............. $11,767 $19,450
Weighted average floor rate................................. 5.34% 5.44%
</Table>
NOTE 11 TEXTRON FINANCIAL AND LITCHFIELD OBLIGATED MANDATORY REDEEMABLE
PREFERRED SECURITIES OF TRUST SUBSIDIARY HOLDING SOLELY LITCHFIELD JUNIOR
SUBORDINATED DEBENTURES
Prior to Textron Financial's acquisition of Litchfield on November 3, 1999,
a trust, sponsored and wholly-owned by Litchfield, issued to the public $26.2
million of mandatory redeemable preferred securities (Preferred Securities). The
trust subsequently invested in $26.2 million aggregate principal amount of
Litchfield 10% Series A Junior Subordinated Debentures (Series A Debentures),
due 2029. The Series A Debentures are the sole asset of the trust. The amounts
due to the trust under the Series A Debentures and the related income statement
amounts have been eliminated in Textron Financial's consolidated financial
statements.
The Preferred Securities were recorded by Textron Financial at the fair
value of $28.6 million as of the acquisition date and the fair value adjustment
is being amortized through June 2004.
The Preferred Securities accrue and pay cash distributions quarterly at a
rate of 10% per annum. The trust's obligations under the Preferred Securities
are fully and unconditionally guaranteed by Litchfield, including, without
limitation, all obligations arising under the Declaration Trust, the Trust
Preferred Securities, the Indenture, the Debentures and the ancillary agreements
entered into in connection with the foregoing. The trust will redeem all of the
outstanding Preferred Securities when the Series A Debentures are paid at
maturity on June 30, 2029, or otherwise become due. Litchfield will have the
right to redeem 100% of the principal plus accrued and unpaid interest on or
after June 30, 2004.
As a result of the acquisition, Textron Financial has agreed to make
payments to the holders of the Preferred Securities, when due, to the extent not
paid by or on behalf of the trust or the subsidiary.
44
NOTE 12 INVESTMENT IN PARENT COMPANY PREFERRED STOCK
On April 12, 2000, Textron made a $25 million noncash capital contribution
to Textron Financial consisting of all of the outstanding shares of Textron
Funding Corporation (Textron Funding), a related corporate holding company.
Textron Funding's only asset is 1,522 shares of Textron Inc. Series D cumulative
preferred stock, bearing an annual dividend yield of 5.92%. The preferred stock,
which has a face value of $152.2 million, is carried at its original cost of $25
million and is presented in a manner similar to treasury stock for financial
reporting purposes. Dividends on the preferred stock are treated as additional
capital contributions from Textron.
NOTE 13 ACCUMULATED OTHER COMPREHENSIVE LOSS
<Table>
<Caption>
DECEMBER 29,
2001
---------------
(In thousands)
Beginning of year........................................... --
Transition adjustment due to change in accounting for
derivative instruments and hedging activities, net of
income tax benefits of $6,948............................. $(11,580)
Net deferred loss on hedge contracts, net of income tax
benefits of $6,395........................................ (10,659)
Amortization of deferred loss on terminated hedge contracts,
net of income taxes of $1,728............................. 2,880
Net deferred gain on interest-only securities, net of income
taxes of $340............................................. 566
--------
End of year................................................. $(18,793)
========
</Table>
There were no items of Other comprehensive income during 2000 or 1999.
NOTE 14 INCOME TAXES
Income before income taxes and distributions on preferred securities is as
follows:
<Table>
<Caption>
2001 2000 1999
-------- -------- --------
(In thousands)
United States............................................ $191,556 $189,705 $126,837
Foreign.................................................. 889 2,291 1,695
-------- -------- --------
Total............................................ $192,445 $191,996 $128,532
======== ======== ========
</Table>
The components of income taxes were as follows:
<Table>
<Caption>
2001 2000 1999
------- ------- -------
(In thousands)
Current:
Federal................................................... $26,752 $51,666 $47,514
State..................................................... 2,321 3,732 5,666
Foreign................................................... 702 1,078 763
------- ------- -------
Total current income taxes.................................. 29,775 56,476 53,943
Deferred:
Federal................................................... 37,423 16,152 (6,145)
State..................................................... 3,241 (43) 1,587
------- ------- -------
Total deferred income taxes....................... 40,664 16,109 (4,558)
------- ------- -------
Total income taxes................................ $70,439 $72,585 $49,385
======= ======= =======
</Table>
Cash paid for income taxes was $15.8 million in 2001, $77.2 million in 2000
and $34.9 million in 1999.
45
The federal statutory income tax rate was reconciled to the effective
income tax rate as follows:
<Table>
<Caption>
2001 2000 1999
---- ---- ----
Federal statutory income tax rate........................... 35.0% 35.0% 35.0%
State income taxes.......................................... 1.6 2.1 4.0
Tax exempt interest......................................... (0.3) (0.3) (0.3)
Foreign tax rate differential............................... (0.5) (0.1) --
Goodwill.................................................... 1.7 1.7 0.6
Other, net.................................................. (0.9) (0.6) (0.9)
---- ---- ----
Effective income tax rate................................... 36.6% 37.8% 38.4%
==== ==== ====
</Table>
The components of Textron Financial's deferred tax assets and liabilities
were as follows:
<Table>
<Caption>
2001 2000
-------- --------
(In thousands)
Deferred tax assets:
Allowance for losses...................................... $ 34,755 $ 32,401
State net operating losses................................ 10,294 6,947
Deferred origination fees................................. 6,308 3,238
Nonaccrual loans.......................................... 3,383 2,003
Other..................................................... 30,589 23,612
-------- --------
Total deferred tax assets................................... 85,329 68,201
Less: valuation allowance................................... (4,626) (1,042)
-------- --------
Net deferred tax assets..................................... 80,703 67,159
======== ========
Deferred tax liabilities:
Leveraged leases.......................................... 279,979 264,898
Finance leases............................................ 86,167 73,099
Equipment on operating leases............................. 34,957 27,948
Other..................................................... 36,924 16,536
-------- --------
Total deferred tax liabilities.................... 438,027 382,481
-------- --------
Net deferred tax liabilities...................... $357,324 $315,322
======== ========
</Table>
At December 29, 2001, Textron Financial had state net operating loss
carryforwards of approximately $341 million available to offset future state
taxable income. The state net operating loss carryforwards will expire in years
2002 through 2020. The valuation allowance reported above represents the tax
effect of certain state net operating loss carryforwards. Textron Financial is
unable to conclude that "more likely than not" it will realize the benefit from
such carryforwards.
NOTE 15 FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used in estimating the fair
value of Textron Financial's financial instruments:
Finance Receivables
The estimated fair values of fixed rate installment contracts, revolving
loans, golf course and resort mortgages and floorplan receivables were estimated
based on discounted cash flow analyses using interest rates currently being
offered for similar loans to borrowers of similar credit quality. Estimated
future cash flows were adjusted for estimates of prepayments, refinances and
loan losses based on internal historical data. The estimated fair values of all
variable rate receivables approximated the net carrying value of such
receivables. The estimated fair values of nonperforming loans were based on
independent appraisals, discounted cash flow
46
analyses using risk adjusted interest rates or Textron Financial valuations
based on the fair value of the related collateral. The fair values, net of
carrying amounts of Textron Financial's leveraged leases, finance leases and
operating leases ($404.4 million, $318.9 million and $201.1 million,
respectively, at December 29, 2001, and $361.0 million, $360.6 million and
$135.4 million, respectively, at December 30, 2000), are not required to be
disclosed under generally accepted accounting principles. As a result, a
significant portion of the assets which are included in the Company's asset and
liability management strategy are excluded from this fair value disclosure.
Debt, Interest Rate Exchange Agreements, Foreign Currency Forward Exchange
Contracts and Foreign Currency Exchange Agreement
The estimated fair value of fixed rate debt and variable rate long-term
notes was determined by either independent investment bankers or discounted cash
flow analyses using interest rates for similar debt with maturities similar to
the remaining terms of the existing debt. The fair values of short-term
borrowings supported by credit facilities approximated their carrying values.
The estimated fair values of interest rate exchange agreements, foreign currency
forward exchange contracts and the foreign currency exchange agreement were
determined by independent investment bankers and represent the estimated amounts
that Textron Financial would be required to pay to (or collect from) a
third-party to assume Textron Financial's obligations under the agreements.
The carrying values and estimated fair values of Textron Financial's
financial instruments for which it is practicable to calculate a fair value are
as follows:
<Table>
<Caption>
2001 2001 2000 2000
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
---------- ---------- ---------- ----------
(In thousands)
ASSETS:
Installment contracts..................... $2,055,407 $2,025,030 $1,985,304 $1,966,244
Interest rate exchange agreements on
installment contracts................... (8,319) (8,319) -- (5,930)
Revolving loans........................... 1,578,922 1,576,250 1,304,591 1,304,591
Golf course and resort mortgages.......... 811,534 811,834 678,409 677,197
Floorplan receivables..................... 474,391 470,531 894,037 891,572
Retained interests in securitizations..... 257,538 257,538 129,608 129,608
Short-term investments.................... 63,819 63,819 -- --
Investments in equity partnerships........ 10,937 10,937 12,261 12,261
Commercial real estate mortgages.......... 417 -- 5,450 450
Allowance for losses on receivables....... (125,261) -- (100,837) --
---------- ---------- ---------- ----------
$5,119,385 $5,207,620 $4,908,823 $4,975,993
========== ========== ========== ==========
LIABILITIES:
Total short-term debt..................... $1,197,707 $1,197,707 $ 965,802 $ 965,802
Variable rate long-term notes............. 1,992,113 1,958,005 2,269,185 2,269,185
Variable rate long-term notes related
derivatives............................. (3,763) (3,763) -- 18,411
Fixed rate long-term debt................. 1,512,363 1,566,268 1,431,882 1,452,726
Amounts due to Textron Inc................ 20,928 17,679 21,620 17,415
Retained interests in securitizations..... 22,739 22,739 -- --
Foreign currency forward exchange
contracts............................... 258 258 97 97
---------- ---------- ---------- ----------
$4,742,345 $4,758,893 $4,688,586 $4,723,636
========== ========== ========== ==========
</Table>
47
NOTE 16 COMMITMENTS
Textron Financial generally enters into various revolving lines of credit,
letters of credit and loan commitments in response to the financing needs of its
customers. The revolving lines of credit include both committed and uncommitted
facilities. Included in the committed facilities are $465 million of commitments
where funding is dependent on compliance with customary financial covenants.
Advances under the remaining $870 million of committed facilities is dependent
on both compliance with customary financial covenants and the availability of
eligible collateral. Advances under the uncommitted facilities of $599 million
are generally at Textron Financial's discretion and the Company has the right to
reduce or cancel these lines at any time. Letters of credit are conditional
commitments issued by the Company to guarantee the performance of a borrower or
an affiliate to a third-party. Loan commitments represent agreements to fund
eligible costs of assets generally within one year. Generally, interest rates on
all of these commitments are not set until amounts are funded. Therefore,
Textron Financial is not exposed to interest rate changes.
These financial instruments generate fees and involve, to varying degrees,
elements of credit risk in excess of amounts recognized in the Consolidated
Balance Sheets. Since many of the agreements are expected to expire unused, the
total commitment amount does not necessarily represent future cash requirements.
The credit risk involved in issuing these instruments is essentially the same as
that involved in extending loans to borrowers and the credit quality and
collateral policies for controlling this risk are similar to those involved in
the Company's normal lending transactions.
The contractual amounts of the Company's outstanding commitments to extend
credit at December 29, 2001, are shown below:
<Table>
<Caption>
(In millions)
Commitments to extend credit:
Committed revolving lines of credit......................... $1,335
Uncommitted revolving lines of credit....................... 599
Loans....................................................... 77
Standby letters of credit................................... 85
Other letters of credit..................................... 49
</Table>
Textron Financial's offices are occupied under noncancelable operating
leases expiring on various dates through 2007. Rental expense was $6.4 million
in 2001 ($5.4 million in 2000 and $4.4 million in 1999). Future minimum rental
commitments for all noncancelable operating leases in effect at December 29,
2001, approximated $5.9 million for 2002, $5.0 million for 2003, $3.3 million
for 2004, $1.6 million for 2005 and $0.7 million for 2006. Of these amounts,
$1.7 million in 2002, $1.4 million in 2003 and $0.3 million in 2004 are payable
to Textron and its subsidiaries.
NOTE 17 CONTINGENCIES
There are pending or threatened lawsuits and other proceedings against
Textron Financial and its subsidiaries. Some of these suits and proceedings seek
compensatory, treble or punitive damages in substantial amounts. These suits and
proceedings are being defended or contested on behalf of Textron Financial and
its subsidiaries. On the basis of information presently available, Textron
Financial believes any such liability would not have a material effect on
Textron Financial's net income or financial condition.
NOTE 18 FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
During 2001, the Company decided to exit certain of its businesses and
product lines and to realign its remaining businesses in four operating
segments: Specialty Finance, Revolving Credit, Structured Capital and Aircraft
Finance. In order to manage the orderly liquidation of the portfolios relating
to the exited businesses and to segregate their results from its ongoing
businesses, the Company has grouped their results in the Other segment.
48
<Table>
<Caption>
2001 2000 1999
----------------- ----------------- -----------------
(In thousands)
Revenues
Specialty Finance............... $ 225,076 32% $ 238,576 35% $ 110,412 24%
Revolving Credit................ 158,585 22% 123,828 18% 97,428 21%
Structured Capital.............. 127,290 18% 92,723 13% 50,636 11%
Aircraft Finance................ 124,643 18% 161,172 23% 103,264 22%
Other........................... 73,642 10% 74,222 11% 101,163 22%
---------- --- ---------- --- ---------- ---
TOTAL REVENUES.................... $ 709,236 100% $ 690,521 100% $ 462,903 100%
---------- --- ---------- --- ---------- ---
Income before special charges,
income taxes and distributions
on preferred securities(1)(2)
Specialty Finance............... $ 81,100 $ 82,990 $ 40,144
Revolving Credit................ 45,763 19,123 21,693
Structured Capital.............. 55,838 33,818 22,490
Aircraft Finance................ 34,821 50,386 31,967
Other........................... (22,391) 5,679 12,238
---------- ---------- ----------
TOTAL INCOME BEFORE SPECIAL
CHARGES, INCOME TAXES AND
DISTRIBUTIONS ON PREFERRED
SECURITIES...................... $ 195,131 $ 191,996 $ 128,532
---------- ---------- ----------
Special charges................... (2,686) -- --
---------- ---------- ----------
TOTAL INCOME BEFORE INCOME TAXES
AND DISTRIBUTIONS ON PREFERRED
SECURITIES...................... $ 192,445 $ 191,996 $ 128,532
---------- ---------- ----------
Finance assets(3)
Specialty Finance............... $2,434,318 $2,063,838 $1,856,722
Revolving Credit................ 1,221,751 1,258,066 914,182
Structured Capital.............. 1,152,360 909,153 659,658
Aircraft Finance................ 1,248,305 1,088,811 1,464,533
Other........................... 251,499 647,758 915,810
---------- ---------- ----------
TOTAL FINANCE ASSETS.............. $6,308,233 $5,967,626 $5,810,905
========== ========== ==========
</Table>
- ---------------
(1) Interest expense is allocated to each segment in proportion to its net
investment in finance assets. Net investment in finance assets includes
deferred income taxes, security deposits and other specifically identified
liabilities. The interest allocated matches variable rate debt with variable
rate financing assets and fixed rate debt with fixed rate financing assets.
(2) Indirect expenses are allocated to each segment based on the use of such
resources. Most allocations are based on the segment's proportion of net
investment in finance assets, headcount, number of transactions, computer
resources and senior management time.
(3) Finance assets include: finance receivables; equipment on operating leases,
net of accumulated depreciation; repossessed assets; retained interests in
securitizations; investment in equipment residuals and short and long-term
investments (some of which are classified in Other assets on Textron
Financial's Consolidated Balance Sheets).
49
NOTE 19 QUARTERLY FINANCIAL DATA (UNAUDITED)
<Table>
<Caption>
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------------- ------------------- ------------------- -------------------
2001 2000 2001 2000 2001 2000 2001 2000
-------- -------- -------- -------- -------- -------- -------- --------
(In thousands)
Revenues............. $170,702 $151,987 $163,986 $169,710 $177,886 $184,526 $196,662 $184,298
Expenses............. 124,667 110,548 124,372 124,879 130,619 135,338 137,133 127,760
Net income........... 28,426 25,084 24,434 27,160 29,911 30,417 37,800 35,355
</Table>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Omitted per Instruction I of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Omitted per Instruction I of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Omitted per Instruction I of Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Omitted per Instruction I of Form 10-K.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statements of Textron Financial and
subsidiaries are included in Item 8:
1. Consolidated statements of income -- Years ended December 29, 2001,
December 30, 2000 and January 1, 2000
2. Consolidated balance sheets -- December 29, 2001 and December 30, 2000
3. Consolidated statements of cash flows -- Years ended December 29, 2001,
December 30, 2000 and January 1, 2000
4. Consolidated statements of changes in shareholder's equity -- Years
ended December 29, 2001, December 30, 2000 and January 1, 2000
5. Notes to consolidated financial statements -- December 29, 2001
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
50
EXHIBITS
The following is an Index of Exhibits required by Item 601 of Regulation
S-K filed with the Securities and Exchange Commission as part of this report.
<Table>
<Caption>
EXHIBIT
NO.
- --------
3.1* Restated Certificate of Incorporation of Textron Financial,
dated July 19, 1993
3.2** By-Laws of Textron Financial as of May 2, 2000
4.1*** Indenture dated as of December 9, 1999, between Textron
Financial Corporation and SunTrust Bank (formerly known as
Sun Trust Bank, Atlanta), (including form of debt
securities)
4.2**** Indenture dated as of November 30, 2001, between Textron
Financial Canada Funding Corp. and SunTrust Bank, guaranteed
by Textron Financial Corporation
10.1* Support Agreement dated as of May 25, 1994, between Textron
Financial and Textron
10.2* Receivables Purchase Agreement between Textron Financial and
Textron dated as of January 1, 1986
10.3* Tax Sharing Agreement between Textron Financial and Textron
dated as of December 29, 1990
12 Computation of Ratios of Earnings to Fixed Charges
23 Consent of Independent Auditors
24 Power of Attorney dated as of February 26, 2002
</Table>
- ---------------
Note: Instruments defining the rights of holders of certain issues of long-term
debt of Textron Financial have not been filed as exhibits to this Report
because the authorized principal amount of any one of such issues does
not exceed 10% of the total assets of Textron Financial and its
subsidiaries on a consolidated basis. Textron Financial agrees to furnish
a copy of each such instrument to the Commission upon request.
* Incorporated by reference to the Exhibit with the same number of Textron
Financial's Registration Statement on Form 10 (File No. 0-27559)
** Incorporated by reference to Exhibit 3.1 of Textron Financial's quarterly
report on Form 10-Q dated August 11, 2000
*** Incorporated by reference to Exhibit 4.1 to Amendment No. 2 to Textron
Financial Corporation's Registration Statement on Form S-3 (No. 333-88509)
**** Incorporated by reference to Exhibit 4.2 to Amendment No. 1 to Textron
Financial Corporation's Registration Statement on Form S-3 (No. 333-72676)
51
REPORTS ON FORM 8-K
The Company filed a report on Form 8-K on December 17, 2001, reporting
under Item 5 of Form 8-K the Company's shelf registration statement on Form S-3
authorizing the sale of medium-term notes.
Textron Financial, Textron, Bell Helicopter, Cessna, Cessna Finance Corporation,
Asset Control, LLC, Textron Business Services, Inc., Textron Golf, Turf and
Specialty Products, OmniQuip, Litchfield Financial Corporation and RFC Capital
Corporation and their related trademark designs and logotypes (and variations of
the foregoing) are trademarks, trade names or service marks of Textron Inc., its
subsidiaries, affiliates or joint ventures.
52
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized on
this 13th day of March 2002.
Textron Financial Corporation
Registrant
By: *
------------------------------------
Stephen A. Giliotti
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below on this 13th day of March 2002, by the following
persons on behalf of the registrant and in the capacities indicated:
By: *
------------------------------------
Stephen A. Giliotti
Chairman and Chief Executive
Officer,
Director (Principal Executive
Officer)
By: *
------------------------------------
Lewis B. Campbell
Director
By: *
------------------------------------
Ted R. French
Director
By: *
------------------------------------
Mary F. Lovejoy
Director
By: *
------------------------------------
Terrence O'Donnell
Director
By: /s/ THOMAS J. CULLEN
------------------------------------
Thomas J. Cullen
Executive Vice President and Chief
Financial
Officer (Principal Financial
Officer)
By: /s/ ERIC SALANDER
------------------------------------
Eric Salander
Senior Vice President, Finance
(Principal Accounting Officer)
*By: /s/ ELIZABETH C. PERKINS
-----------------------------------
Elizabeth C. Perkins
Attorney-in-fact
53